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Determinacy, indeterminacy and dynamic misspecification in linear rational expectations models

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  • Luca Fanelli

    (luca.fanelli@unibo.it)

Abstract

This paper proposes a testing strategy for the null hypothesis that a multivariate linear rational expectations (LRE) model has a unique stable solution (determinacy) against the alternative of multiple stable solutions (indeterminacy). Under a proper set of identification restrictions, determinacy is investigated by a misspecification-type approach in which the result of the overidentifying restrictions test obtained from the estimation of the LRE model through a version of generalized method of moments is combined with the result of a likelihood-based test for the cross-equation restrictions that the LRE places on its finite order reduced form under determinacy. This approach (i) circumvents the nonstandard inferential problem that a purely likelihood-based approach implies because of the presence of nuisance parameters that appear under the alternative but not under the null, (ii) does not involve inequality parametric restrictions and nonstandard asymptotic distributions, and (iii) gives rise to a joint test which is consistent against indeterminacy almost everywhere in the space of nuisance parameters, i.e. except for a point of zero measure which gives rise to minimum state variable solutions, and is also consistent against the dynamic misspecification of the LRE model. Monte Carlo simulations show that the testing strategy delivers reasonable size coverage and power in finite samples. An empirical illustration focuses on the determinacy/indeterminacy of a New Keynesian monetary business cycle model for the US.

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Bibliographic Info

Paper provided by Department of Statistics, University of Bologna in its series Quaderni di Dipartimento with number 4.

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Length: 40
Date of creation: 2010
Date of revision:
Handle: RePEc:bot:quadip:100

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Keywords: Determinatezza; Indeterminatezza; Massima verosimiglianza; Metodo generalizzato dei momenti; Modello lineare con aspettative; Identificazione; Variabili Strumentali; VAR; VARMA Determinacy; Generalized method of moments; Indeterminacy; LRE model; Identification; Instrumental Variables; Maximum Likelihood; VAR; VARMA;

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References

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Citations

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Cited by:
  1. Marco M. Sorge, 2013. "On the Fundamentalness of Nonfundamentalness in DSGE Models," CSEF Working Papers 340, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
  2. Sorge, Marco M., 2012. "News shocks or parametric indeterminacy? An observational equivalence result in linear rational expectations models," Economics Letters, Elsevier, vol. 114(2), pages 198-200.
  3. Gunnar Bårdsen & Luca Fanelli, 2013. "Frequentist evaluation of small DSGE models," Working Paper Series 14113, Department of Economics, Norwegian University of Science and Technology.

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