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Inequality Constraints and Euler Equation based Solution Methods

  • Pontus Rendahl

Solving dynamic models with inequality constraints poses a challenging problem for two major reasons: dynamic programming techniques are reliable but often slow, while Euler equation based methods are fast but have problematic or unknown convergence properties. This paper attempts to bridge this gap. I show that a common iterative procedure on the Euler equation { usually referred to as time iteration { delivers a sequence of approximate policy functions that converges to the true solution under a wide range of circumstances. These circumstances extend to an arbitrarily large, but nite, set of endogenous and exogenous state-variables as well as a very broad spectrum of occasionally binding constraints.

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File URL: http://www.econ.cam.ac.uk/research/repec/cam/pdf/cwpe1320.pdf
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Paper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 1320.

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Date of creation: 02 Jun 2013
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Handle: RePEc:cam:camdae:1320
Contact details of provider: Web page: http://www.econ.cam.ac.uk/index.htm

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