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On the Estimation of Euler Equations in the Presence of a Potential Regime Shift

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  • Pentti Saikkonen
  • Antti Ripatti

Abstract

The concept of a peso problem is formalized in terms of a linear Euler equation and a non‐linear marginal model describing the dynamics of the exogenous variable driving the process. It is shown that, using a threshold autoregressive model as a marginal model, it is possible to produce time‐varying peso premia. A Monte Carlo method and a method based on the numerical solution of integral equations are considered as tools for computing conditional future expectations in the marginal model. A Monte Carlo study illustrates the poor performance of the generalized method of moments estimator in small and even relatively large samples. The poor performance is particularly acute in the presence of a peso problem but is also serious in the simple linear case.

Suggested Citation

  • Pentti Saikkonen & Antti Ripatti, 2000. "On the Estimation of Euler Equations in the Presence of a Potential Regime Shift," Manchester School, University of Manchester, vol. 68(s1), pages 92-121.
    • Handle: RePEc:bla:manchs:v:68:y:2000:i:s1:p:92-121
    DOI: 10.1111/1467-9957.68.s1.6
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    Cited by:

    1. Juan Carlos Parra‐Alvarez & Olaf Posch & Andreas Schrimpf, 2022. "Peso problems in the estimation of the C‐CAPM," Quantitative Economics, Econometric Society, vol. 13(1), pages 259-313, January.
    2. Christian Julliard & Anisha Ghosh, 2012. "Can Rare Events Explain the Equity Premium Puzzle?," The Review of Financial Studies, Society for Financial Studies, vol. 25(10), pages 3037-3076.
    3. Daniel G. Swaine, 2001. "Are taste and technology parameters stable? a test of \"deep\" parameter stability in real business cycle models of the U.S. economy," Working Papers 01-05, Federal Reserve Bank of Boston.
    4. Markku Lanne, 2003. "Testing the Expectations Hypothesis of the Term Structure of Interest Rates in the Presence of a Potential Regime Shift," Manchester School, University of Manchester, vol. 71(s1), pages 54-67, September.
    5. Hing Chan & Kai Woo, 2006. "Bubbles detection for inter-war European hyperinflation: A threshold cointegration approach," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 30(2), pages 169-185, June.

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