IDEAS home Printed from
   My bibliography  Save this paper

Testing Intertemporal Rational Expectations Model with State Uncertainty: An Application to the Permanent Income Hypothesis


  • Chao-Hsi Huang
  • Yue-Lieh Huang


In this paper we take a different modeling approach based on the component driven (CD) model developed in Kuan, Huang, and Tsay~(2003) to test the permanent income hypothesis (PIH), an example of intertemporal choice models. A key feature of this approach is that it explicitly allows for state uncertainty. By assuming that the labor income follows a CD process, we show that the agent's perception on the likelihoods of income innovations being permanent and transitory plays a crucial role in determining the optimal forecasts on the change of consumption. In particular, the effect of a current innovation is a weighted average of two distinct effects (resulted from permanent and transitory innovations), with the weights being the perceived likelihoods of respective states. Also, past innovations may affect consumption when there is a revision on the perceived likelihoods of previous states. If there is no state uncertainty, our result reduces to that of an existing model. Our empirical study shows that, while the CD model can characterize the U.S. consumption data well, the estimation results do not agree with the predictions of the PIH

Suggested Citation

  • Chao-Hsi Huang & Yue-Lieh Huang, 2004. "Testing Intertemporal Rational Expectations Model with State Uncertainty: An Application to the Permanent Income Hypothesis," Econometric Society 2004 Far Eastern Meetings 598, Econometric Society.
  • Handle: RePEc:ecm:feam04:598

    Download full text from publisher

    File URL:
    Download Restriction: no

    More about this item


    component driven model; intertemporal choice model; permanent income hypothesis; permanent innovation; state uncertainty; transitory innovation;

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making

    NEP fields

    This paper has been announced in the following NEP Reports:


    Access and download statistics


    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ecm:feam04:598. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christopher F. Baum). General contact details of provider: .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.