Testing Intertemporal Rational Expectations Model with State Uncertainty: An Application to the Permanent Income Hypothesis
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
|Date of creation:||11 Aug 2004|
|Contact details of provider:|| Phone: 1 212 998 3820|
Fax: 1 212 995 4487
Web page: http://www.econometricsociety.org/pastmeetings.asp
More information through EDIRC
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)
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.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with 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 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.