We are wondering how many degrees of freedom are sensible in a model and if there is a rule of thumb.

We have a time series of 57 periods, with 4 endogenous variables and 3 exogenous variables in a VAR model. Preferably, we would like to use a lag length of 4 (since our data is quarterly).

We were wondering if that is sensible.

**Contents**hide

#### Best Answer

If you use 4 lags of both the endogenous and the exogenous variables, that is likely too many. You will have as many as $4 times (4 + 3) + 1 = 29$ variables ($+1$ due to the intercept) per equation to be estimated using only 57 data points. You will likely end up with large standard errors and unstable point estimates. This will be bad regardless whether you will use the model for hypothesis testing (you will have low power) or forecasting (you will have high variance).

You could perhaps keep lag 1 and lag 4 (but skip lags 2, 3) and see if the model residuals look alright. Alternatively, you could use Bayesian VAR (BVAR) or perhaps regularized VAR instead. However, regularization normally requires finding the shrinkage parameter from the data (e.g. using cross validation), and that again becomes a problem in small samples.

### Similar Posts:

- Solved – Lagged Exogenous Variables in VECM with R
- Solved – Vector autoregression model with unit root in the exogenous variable and endogenous variables
- Solved – Exogenous variables in dlm package
- Solved – Instrumental variables with dichotomous instrument, variable, and outcome? Can I use TSLS
- Solved – Instrumental variables with dichotomous instrument, variable, and outcome? Can I use TSLS