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When building a vector autoregression model is there some theory that would guide me in chosing the number of variable to include? For example, I have about 3000 data points and I would like to get an idea of how many lags of explanatory variables to ues.

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  • $\begingroup$ Do you know how to do Bayesian VAR? $\endgroup$ – 410 gone Jan 18 '12 at 11:16
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The standard practice is to use some sort of information criterion, usually the Akaike Information Criterion (AIC) or the Schwarz Information Criterion (SIC).

The AIC is defined as $2k-2\log(L)$, where $k$ is the number of parameters, and L is the maximized likelihood function of the model (estimated with k parameters).

The SIC is defined as $k\log(n)-2\log(L)$, where $k$ and $L$ are as above, and $n$ is the number of observations of the model.

In general, one adopts the model that minimizes the chosen criterion.

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