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Ensuring the Validity of the Micro Foundation in DSGE Models

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  • Martin Møller Andreasen

    () (School of Economics and Management, University of Aarhus, Denmark and CREATES)

Abstract

The presence of i) stochastic trends, ii) deterministic trends, and/or iii) stochastic volatil- ity in DSGE models may imply that the agents' objective functions attain infinite values. We say that such models do not have a valid micro foundation. The paper derives sufficient condi- tions which ensure that the objective functions of the households and the firms are finite even when various trends and stochastic volatility are included in a standard DSGE model. Based on these conditions we test the validity of the micro foundation in six DSGE models from the literature. The models of Justiniano & Primiceri (American Economic Review, forth- coming) and Fernández-Villaverde & Rubio-Ramírez (Review of Economic Studies, 2007) do not satisfy these sufficient conditions, or any other known set of conditions ensuring finite values for the objective functions. Thus, the validity of the micro foundation in these models remains to be established.

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Bibliographic Info

Paper provided by School of Economics and Management, University of Aarhus in its series CREATES Research Papers with number 2008-26.

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Length: 43
Date of creation: 26 May 2008
Date of revision:
Handle: RePEc:aah:create:2008-26

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Web page: http://www.econ.au.dk/afn/

Related research

Keywords: Deterministic trends; DSGE models; Error distributions; Moment generating functions; Stochastic trends; Stochastic volatility; Unit-roots;

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References

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Citations

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Cited by:
  1. Martin Møller Andreasen, 2008. "How to Maximize the Likelihood Function for a DSGE Model," CREATES Research Papers 2008-32, School of Economics and Management, University of Aarhus.
  2. Martin Møller Andreasen, 2008. "Non-linear DSGE Models, The Central Difference Kalman Filter, and The Mean Shifted Particle Filter," CREATES Research Papers 2008-33, School of Economics and Management, University of Aarhus.
  3. Martin Møller Andreasen, 2008. "Explaining Macroeconomic and Term Structure Dynamics Jointly in a Non-linear DSGE Model," CREATES Research Papers 2008-43, School of Economics and Management, University of Aarhus.

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