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Likelihood Estimation of DSGE Models with Epstein-Zin Preferences

  • Ralph S.J. Koijen

    (New York University and Tilburg University)

  • Jules H. van Binsbergen

    (Duke University,)

  • Juan F. Rubio-Ramírez

    (Duke University and Federal Reserve Bank of Atlanta.)

  • Jesus Fernandez-Villaverde

    (University of Pennsylvania)

This paper illustrates how to perform likelihood-based inference in dynamic stochastic general equilibrium (DSGE) models with Epstein-Zin preferences. This class of preferences has recently become a popular device to account for asset pricing observations and other phenomena that are challenging to address within the traditional state-separable utility framework. However, there has been little econometric work in the area, particularly from a likelihood perspective, because of the difficulty in computing an equilibrium solution to the model and in deriving the likelihood function. To fill this gap, we build a real business cycle model with Epstein-Zin preferences and long run growth, solve it with perturbation techniques, and evaluate its likelihood with the particle filter. We estimate the model using U.S. macro and yield curve data. We discuss the ability of the model to explain the business cycle, asset prices, the comovements between these two, and the implications of our point estimates for the welfare cost of the business cycle.

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File URL: https://www.economicdynamics.org/meetpapers/2008/paper_1099.pdf
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Paper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 1099.

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Date of creation: 2008
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Handle: RePEc:red:sed008:1099
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  1. Christopher A. Sims & Tao Zha, 2004. "Were there regime switches in U.S. monetary policy?," Working Paper 2004-14, Federal Reserve Bank of Atlanta.
  2. Claudio Campanale & Rui Castro & Gian Luca Clementi, 2010. "Asset Pricing in a Production Economy with Chew-Dekel Preferences," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 13(2), pages 379-402, April.
  3. Levine, Paul & Pearlman, Joseph G. & Pierse, Richard, 2007. "Linear-quadratic approximation, external habit and targeting rules," Working Paper Series 0759, European Central Bank.
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  5. Dario Caldara & Jesus Fernandez-Villaverde & Juan F. Rubio-Ramirez & Wen Yao, 2009. "Computing DSGE Models with Recursive Preferences," PIER Working Paper Archive 09-018, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  6. Manuel S. Santos & Adrian Peralta-Alva, 2005. "Accuracy of Simulations for Stochastic Dynamic Models," Econometrica, Econometric Society, vol. 73(6), pages 1939-1976, November.
  7. Hansen, Lars Peter & Sargent, Thomas J & Tallarini, Thomas D, Jr, 1999. "Robust Permanent Income and Pricing," Review of Economic Studies, Wiley Blackwell, vol. 66(4), pages 873-907, October.
  8. Ravi Bansal & Amir Yaron, 2000. "Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles," NBER Working Papers 8059, National Bureau of Economic Research, Inc.
  9. John Y. Campbell, 1993. "Understanding Risk and Return," NBER Working Papers 4554, National Bureau of Economic Research, Inc.
  10. TallariniJr., Thomas D., 2000. "Risk-sensitive real business cycles," Journal of Monetary Economics, Elsevier, vol. 45(3), pages 507-532, June.
  11. John Y. Campbell, 1992. "Intertemporal Asset Pricing Without Consumption Data," NBER Working Papers 3989, National Bureau of Economic Research, Inc.
  12. Mariano M. Croce, 2006. "Welfare Costs, Long Run Consumption Risk, and a Production Economy," 2006 Meeting Papers 582, Society for Economic Dynamics.
  13. Jim Dolmas, 2007. "Real business cycle dynamics under first-order risk aversion," Working Papers 0704, Federal Reserve Bank of Dallas.
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