Fundamental Problems with Nonfundamental Shocks

Economic agents using information that is not incorporated in the econometric model is seen as a possible reason for why nonfundamental shocks are important in econometric models. Allowing for nonfundamental shocks in structural vector autoregressive (SVAR) analysis by considering moving average (MA) representations with roots in the complex unit circle is a possible response to the problem. A case is made for viewing nonfundamentalness as an omitted variables problem rather than a problem of MA roots in the unit circle. The omitted variables problem will always lurk in the background of SVAR analysis as well as other econometric studies and cannot be avoided. In SVAR analysis it is even more problematic than what the literature on nonfundamental shocks suggests. Still, SVARs can be useful tools for empirical analysis.