A1542
Title: Invalid proxies and volatility changes
Authors: Giovanni Angelini - University of Bologna (Italy)
Luca Neri - Aarhus University (Denmark)
Luca Fanelli - University of Bologna (Italy) [presenting]
Abstract: In proxy-SVARs, the covariance matrix of VAR innovations is subject to exogenous, permanent, nonrecurring breaks that generate target impulse response functions (IRFs) that change across volatility regimes; even strong, exogenous external instruments can result in inconsistent estimates. In such cases, it is essential to explicitly incorporate the shifts in unconditional volatility in order to point-identify the target structural shocks and restore consistency. It is shown that if a necessary and sufficient rank condition based on the moments implied by the changes in volatility holds, the target IRFs can be point-identified and estimated consistently. Importantly, standard asymptotic inference applies despite (i) the covariance between the proxies and the instrumented structural shocks being local-to-zero as in a past study and (ii) the instruments' exogeneity possibly failing. In the worst case, the external instruments merely serve as labels for the target structural shocks. A novel identification strategy is presented that appropriately combines external instruments with changes in volatility regimes, thereby avoiding the need to assume proxy relevance and exogeneity in estimation. The usefulness of the suggested method is illustrated by reexamining some proxy-SVARs previously estimated in the existing literature, including a fiscal proxy-SVAR.
