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Likelihood Estimation of DSGE Models with Epstein-Zin Preferences

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Author Info

  • Ralph S.J. Koijen

    (New York University and Tilburg University)

  • Jules H. van Binsbergen

    (Duke University,)

  • Juan F. Rubio-Ramírez

    (Duke University and Federal Reserve Bank of Atlanta.)

  • Jesus Fernandez-Villaverde

    (University of Pennsylvania)

Abstract

This paper illustrates how to perform likelihood-based inference in dynamic stochastic general equilibrium (DSGE) models with Epstein-Zin preferences. This class of preferences has recently become a popular device to account for asset pricing observations and other phenomena that are challenging to address within the traditional state-separable utility framework. However, there has been little econometric work in the area, particularly from a likelihood perspective, because of the difficulty in computing an equilibrium solution to the model and in deriving the likelihood function. To fill this gap, we build a real business cycle model with Epstein-Zin preferences and long run growth, solve it with perturbation techniques, and evaluate its likelihood with the particle filter. We estimate the model using U.S. macro and yield curve data. We discuss the ability of the model to explain the business cycle, asset prices, the comovements between these two, and the implications of our point estimates for the welfare cost of the business cycle.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 1099.

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Date of creation: 2008
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Handle: RePEc:red:sed008:1099

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  1. John Y. Campbell, 1995. "Understanding Risk and Return," Harvard Institute of Economic Research Working Papers, Harvard - Institute of Economic Research 1711, Harvard - Institute of Economic Research.
  2. TallariniJr., Thomas D., 2000. "Risk-sensitive real business cycles," Journal of Monetary Economics, Elsevier, Elsevier, vol. 45(3), pages 507-532, June.
  3. Ravi Bansal & Amir Yaron, 2000. "Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles," NBER Working Papers 8059, National Bureau of Economic Research, Inc.
  4. Kenneth L. Judd, 1998. "Numerical Methods in Economics," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262100711, December.
  5. John Y. Campbell, 1992. "Intertemporal Asset Pricing Without Consumption Data," NBER Working Papers 3989, National Bureau of Economic Research, Inc.
  6. Manuel S. Santos & Adrian Peralta-Alva, 2005. "Accuracy of Simulations for Stochastic Dynamic Models," Econometrica, Econometric Society, Econometric Society, vol. 73(6), pages 1939-1976, November.
  7. Jim Dolmas, 2007. "Real business cycle dynamics under first-order risk aversion," Working Papers, Federal Reserve Bank of Dallas 0704, Federal Reserve Bank of Dallas.
  8. Dario Caldara & Jesus Fernandez-Villaverde & Juan F. Rubio-Ramirez & Wen Yao, 2009. "Computing DSGE Models with Recursive Preferences," PIER Working Paper Archive, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania 09-018, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  9. Levine, Paul & Pearlman, Joseph & Pierse, Richard, 2008. "Linear-quadratic approximation, external habit and targeting rules," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 32(10), pages 3315-3349, October.
  10. Lars Hansen & Thomas Sargent & Thomas Tallarini, . "Robust Permanent Income and Pricing," GSIA Working Papers, Carnegie Mellon University, Tepper School of Business 1997-51, Carnegie Mellon University, Tepper School of Business.
  11. Alessandra Fogli & Laura Veldkamp, 2007. "Nature or Nurture? Learning and Female Labor Force Dynamics," Working Papers, New York University, Leonard N. Stern School of Business, Department of Economics 07-12, New York University, Leonard N. Stern School of Business, Department of Economics.
  12. Mariano M. Croce, 2006. "Welfare Costs, Long Run Consumption Risk, and a Production Economy," 2006 Meeting Papers, Society for Economic Dynamics 582, Society for Economic Dynamics.
  13. Christopher A. Sims & Tao Zha, 2005. "Were There Regime Switches in U.S. Monetary Policy?," Working Papers, Princeton University, Department of Economics, Center for Economic Policy Studies. 92, Princeton University, Department of Economics, Center for Economic Policy Studies..
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