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Simulation‐based tests of forward‐looking models under VAR learning dynamics

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  • Luca Fanelli
  • Giulio Palomba

Abstract

In this paper we propose simulation-based techniques to investigate the finite sample performance of likelihood ratio (LR) tests for the nonlinear restrictions that arise when a class of forward-looking (FL) models, typically used in monetary policy analysis, is evaluated with Vector Autoregressive (VAR) models. We consider both `one-shot' tests and sequences of tests under a particular form of adaptive learning dynamics, where `boundedly rational' agents use VARs recursively to update their beliefs. The analysis is based on the comparison of the likelihood of the unrestricted and restricted VAR, and the p-values associated with the LR statistics are computed by Monte Carlo simulation. We also address the case where the variables of the FL model are approximated as non-stationary cointegrated processes. Application to the New Keynesian Phillips Curve in the euro area shows that the FL model of inflation dynamics is not rejected once the suggested simulation-based tests are applied. The result is robust to specification of the VAR as a stationary (albeit highly persistent) or cointegrated system. However, in the second case the imposition of cointegration restrictions changes the estimated degree of price stickiness.

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Bibliographic Info

Article provided by John Wiley & Sons, Ltd. in its journal Journal of Applied Econometrics.

Volume (Year): 26 (2011)
Issue (Month): 5 (08)
Pages: 762-782

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Handle: RePEc:wly:japmet:v:26:y:2011:i:5:p:762-782

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  1. Binder,M. & Pesaran,H.M., 1995. "Multivariate Rational Expectations Models and Macroeconomic Modelling: A Review and Some New Results," Cambridge Working Papers in Economics, Faculty of Economics, University of Cambridge 9415, Faculty of Economics, University of Cambridge.
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  8. DUFOUR, Jean-Marie, 2005. "Monte Carlo Tests with Nuisance Parameters: A General Approach to Finite-Sample Inference and Nonstandard Asymptotics," Cahiers de recherche, Universite de Montreal, Departement de sciences economiques 2005-03, Universite de Montreal, Departement de sciences economiques.
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  11. Toda, Hiro Y. & Yamamoto, Taku, 1995. "Statistical inference in vector autoregressions with possibly integrated processes," Journal of Econometrics, Elsevier, Elsevier, vol. 66(1-2), pages 225-250.
  12. Fanelli, Luca, 2005. "Testing the New Keynesian Phillips curve through Vector Autoregressive models: Results from the Euro area," MPRA Paper 1617, University Library of Munich, Germany, revised Jan 2007.
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  15. Mavroeidis, Sophocles, 2005. "Identification Issues in Forward-Looking Models Estimated by GMM, with an Application to the Phillips Curve," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 37(3), pages 421-48, June.
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Cited by:
  1. Fabio FIORILLO & Agnese SACCHI, 2010. "I Want to Free-ride. An Opportunistic View on Decentralization Versus Centralization Problem," Working Papers, Universita' Politecnica delle Marche (I), Dipartimento di Scienze Economiche e Sociali 346, Universita' Politecnica delle Marche (I), Dipartimento di Scienze Economiche e Sociali.
  2. Gunnar Bårdsen & Luca Fanelli, 2013. "Frequentist evaluation of small DSGE models," Working Paper Series, Department of Economics, Norwegian University of Science and Technology 14113, Department of Economics, Norwegian University of Science and Technology.
  3. Nymoen, Ragnar & Rygh Swensen, Anders & Tveter, Eivind, 2011. "Interpreting the evidence for New Keynesian models of inflation dynamics," Memorandum, Oslo University, Department of Economics 23/2011, Oslo University, Department of Economics.
  4. Fanelli, Luca, 2008. "Evaluating New Keynesian Phillips Curve under VAR-Based Learning," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy, vol. 2(33), pages 1-24.
  5. Elena AMBROSETTI & Eralba CELA & Tineke FOKKEMA, 2011. "The Remittances Behaviour of the Second Generation in Europe: Altruism or Self-Interest?," Working Papers, Universita' Politecnica delle Marche (I), Dipartimento di Scienze Economiche e Sociali 368, Universita' Politecnica delle Marche (I), Dipartimento di Scienze Economiche e Sociali.
  6. Luca RICCETTI, 2011. "A Copula-GARCH Model for Macro Asset Allocation of a Portfolio with Commodities: an Out-of-Sample Analysis," Working Papers, Universita' Politecnica delle Marche (I), Dipartimento di Scienze Economiche e Sociali 355, Universita' Politecnica delle Marche (I), Dipartimento di Scienze Economiche e Sociali.
  7. Luca RICCETTI, 2010. "Minimum Tracking Error Volatility," Working Papers, Universita' Politecnica delle Marche (I), Dipartimento di Scienze Economiche e Sociali 340, Universita' Politecnica delle Marche (I), Dipartimento di Scienze Economiche e Sociali.
  8. Ugo FRATESI, 2010. "The National and International Effects;of Regional Policy Choices: Agglomeration Economies, Peripherality and Territorial Characteristics," Working Papers, Universita' Politecnica delle Marche (I), Dipartimento di Scienze Economiche e Sociali 344, Universita' Politecnica delle Marche (I), Dipartimento di Scienze Economiche e Sociali.

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