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Solution of Nonlinear Rational Expectations Models with Applications to Finite-Horizon Life-Cycle Models of Consumption

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  • Binder, Michael
  • Pesaran, M Hashem
  • Samiei, S Hossein

Abstract

This paper considers the solution of nonlinear rational expectations models resulting from the optimality conditions of a finite-horizon intertemporal optimization problem satisfying Bellman's principle of optimality (and possibly involving inequality constraints). A backward recursive procedure is used to characterize and solve the time-varying optimal decision rules generally associated with these models. At each stage of these backward recursions, either an analytical or numerical solution of the optimality conditions is required. When an analytical solution is not possible, a minimum weighted residual approach is used. The solution technique is illustrated using a life-cycle model of consumption under labor income and interest rate uncertainties (and possibly involving liquidity constraints). Approximate numerical solutions are provided and compared with certainty-equivalent solutions and, when possible, with exact solutions. Citation Copyright 2000 by Kluwer Academic Publishers.

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  • Binder, Michael & Pesaran, M Hashem & Samiei, S Hossein, 2000. "Solution of Nonlinear Rational Expectations Models with Applications to Finite-Horizon Life-Cycle Models of Consumption," Computational Economics, Springer;Society for Computational Economics, vol. 15(1-2), pages 25-57, April.
  • Handle: RePEc:kap:compec:v:15:y:2000:i:1-2:p:25-57
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    Cited by:

    1. Suen, Richard M. H., 2011. "Concave consumption function and precautionary wealth accumulation," MPRA Paper 34774, University Library of Munich, Germany.
    2. Ray Fair, 2001. "Optimal Control and Stochastic Simulation of Large Nonlinear Models with Rational Expectations," Yale School of Management Working Papers ysm202, Yale School of Management, revised 24 Sep 2001.
    3. Binder, Michael & Pesaran, Hashem, 2000. "Solution of finite-horizon multivariate linear rational expectations models and sparse linear systems," Journal of Economic Dynamics and Control, Elsevier, vol. 24(3), pages 325-346, March.
    4. Ray Fair, 2003. "Optimal Control and Stochastic Simulation of Large Nonlinear Models with Rational Expectations," Computational Economics, Springer;Society for Computational Economics, vol. 21(3), pages 245-256, June.
    5. Binder, Michael & Pesaran, M. Hashem, 2001. "Life-cycle consumption under social interactions," Journal of Economic Dynamics and Control, Elsevier, vol. 25(1-2), pages 35-83, January.

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