Asymmetry in the Business Model: Revisiting the Friedman Plucking Model

Recent research suggests that unobserved components models can, under certain conditions, be estimated without imposing the common zero-correlation restriction between the permanent and transitory innovations. The impact of this restriction, however, has not previously been examined in an unobserved components model with asymmetric movements. This paper produces and estimates an unobserved components model that allows for both correlation between the innovations and asymmetric transitory movements. The asymmetry is modeled using Markov-switching in the transitory component, in the spirit of the Kim and Nelson (1999) version of the Friedman plucking model. The results reveal that U.S. real GDP can be decomposed into a permanent component, a symmetric transitory component, and an additional occasional asymmetric transitory shock. The innovations to the permanent component and the symmetric transitory component are significantly negatively correlated, but the asymmetric transitory shock is exogenous. The findings suggest that both permanent movements and asymmetric transitory shocks are important for explaining post-war output fluctuations in the U.S.