Inaccuracy of Loglinear Approximation in Welfare Calculations: the Case of International Risk Sharing
This paper investigates the accuracy of the log-linear approximation method in welfare calculations, especially in measuring welfare gains of international risk sharing. We derive closed-form solutions for a two-country complete market economy using log-linearization and a nonlinear solution method and compare risk-sharing gains over financial autarky. We document that the loglinearized model underestimates risk-sharing gains by up to 20% of world consumption under certain parameter values with endogenous labor supply. While the nonlinear solution generates 4% risk-sharing gains, the loglinear approximation results in a loss of 16%. Loglinear approximation errors are large enough to generate welfare reversal between autarky and complete market economies, a violation of the first welfare theorem. This result can be crucial because a large number of papers adopt loglinearization method in calculating welfare.
To our knowledge, this item is not available for
download. To find whether it is available, there are three
1. Check below under "Related research" whether another version of this item is available online.
2. Check on the provider's web page whether it is in fact available.
3. Perform a search for a similarly titled item that would be available.
|Date of creation:||01 Mar 1999|
|Date of revision:|
|Contact details of provider:|| Postal: |
Web page: http://fmwww.bc.edu/CEF99/
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Benigno, Gianluca & Benigno, Pierpaolo, 2001. "Monetary Policy Rules and the Exchange Rate," CEPR Discussion Papers 2807, C.E.P.R. Discussion Papers.
- Dale Henderson & Jinill Kim, 1999.
"Exact Utilities under Alternative Monetary Rules in a Simple Macro Model with Optimizing Agents,"
International Tax and Public Finance,
Springer, vol. 6(4), pages 507-535, November.
- Dale W. Henderson & Jinill Kim, 1999. "Exact utilities under alternative monetary rules in a simple macro model with optimizing agents," International Finance Discussion Papers 635, Board of Governors of the Federal Reserve System (U.S.).
- Harold L. Cole & Maurice Obstfeld, 1989.
"Commodity Trade and International Risk Sharing: How Much Do Financial Markets Matter?,"
NBER Working Papers
3027, National Bureau of Economic Research, Inc.
- Cole, Harold L. & Obstfeld, Maurice, 1991. "Commodity trade and international risk sharing : How much do financial markets matter?," Journal of Monetary Economics, Elsevier, vol. 28(1), pages 3-24, August.
- Wouter J. den Haan & Albert Marcet, 1993.
"Accuracy in simulations,"
Economics Working Papers
42, Department of Economics and Business, Universitat Pompeu Fabra.
- repec:cup:macdyn:v:1:y:1997:i:1:p:45-75 is not listed on IDEAS
- David K. Backus & Patrick J. Kehoe & Finn E. Kydland, 1991.
"International real business cycles,"
146, Federal Reserve Bank of Minneapolis.
- Jess Gaspar & Kenneth L. Judd, 1997.
"Solving Large Scale Rational Expectations Models,"
NBER Technical Working Papers
0207, National Bureau of Economic Research, Inc.
- Otrok, Christopher, 2001.
"On measuring the welfare cost of business cycles,"
Journal of Monetary Economics,
Elsevier, vol. 47(1), pages 61-92, February.
- Chris Otrok, 1999. "On Measuring the Welfare Cost of Business Cycles," Virginia Economics Online Papers 318, University of Virginia, Department of Economics.
- Christopher Otrok, 2000. "On Measuring the Welfare Cost of Business Cycles," Econometric Society World Congress 2000 Contributed Papers 1094, Econometric Society.
- Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000.
"Optimal monetary policy with staggered wage and price contracts,"
Journal of Monetary Economics,
Elsevier, vol. 46(2), pages 281-313, October.
- Ryo Kato & Takayuki Tsuruga, 2002. "Matlab code for a sticky wage/price model," QM&RBC Codes 114, Quantitative Macroeconomics & Real Business Cycles.
- Tom Doan, . "RATS program to solve Erceg-Henderson-Levin model," Statistical Software Components RTZ00051, Boston College Department of Economics.
- Christopher J. Erceg & Dale W. Henderson & Andrew T. Levin, 1999. "Optimal monetary policy with staggered wage and price contracts," International Finance Discussion Papers 640, Board of Governors of the Federal Reserve System (U.S.).
- Andrew Levin & Christopher J. Erceg & Dale W. Henderson, 1999. "Optimal Monetary Policy with Staggered Wage and Price Contracts," Computing in Economics and Finance 1999 1151, Society for Computational Economics.
- John B. Taylor & Harald Uhlig, 1989.
"Solving Nonlinear Stochastic Growth Models: A Comparison of Alternative Solution Methods,"
NBER Working Papers
3117, National Bureau of Economic Research, Inc.
- Taylor, John B & Uhlig, Harald, 1990. "Solving Nonlinear Stochastic Growth Models: A Comparison of Alternative Solution Methods," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(1), pages 1-17, January.
- Tesar, Linda L., 1995. "Evaluating the gains from international risksharing," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 42(1), pages 95-143, June.
- Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
- Jang-Ok Cho & Thomas Cooley & Louis Phaneuf, 1994.
"The Welfare Costs of Nominal Wage Contracting,"
Cahiers de recherche CREFE / CREFE Working Papers
30, CREFE, Université du Québec à Montréal, revised 22 Jan 1996.
- Michael Woodford, 2001.
"Inflation Stabilization and Welfare,"
NBER Working Papers
8071, National Bureau of Economic Research, Inc.
- Devereux, Michael B. & Saito, Makoto, 1997. "Growth and risk-sharing with incomplete international assets markets," Journal of International Economics, Elsevier, vol. 42(3-4), pages 453-481, May.
- Ireland, Peter N., 1997. "A small, structural, quarterly model for monetary policy evaluation," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 47(1), pages 83-108, December.
- Collard, Fabrice & Juillard, Michel, 2001.
"Accuracy of stochastic perturbation methods: The case of asset pricing models,"
Journal of Economic Dynamics and Control,
Elsevier, vol. 25(6-7), pages 979-999, June.
- Collard, Fabrice & Juillard, Michel, 1999. "Accuracy of stochastic perturbuation methods: the case of asset pricing models," CEPREMAP Working Papers (Couverture Orange) 9922, CEPREMAP.
- Mark Bils & Yongsung Chang, 1999. "Wages and the Allocation of Hours and Effort," NBER Working Papers 7309, National Bureau of Economic Research, Inc.
- Obstfeld, M., 1998.
"Risk and Exchange Rate,"
193, Princeton, Woodrow Wilson School - Public and International Affairs.
- Kydland, Finn E & Prescott, Edward C, 1982.
"Time to Build and Aggregate Fluctuations,"
Econometric Society, vol. 50(6), pages 1345-70, November.
- Finn E. Kydland & Edward C. Prescott, 1982. "Web interface for "Time to Build and Aggregate Fluctuations"," QM&RBC Codes 4a, Quantitative Macroeconomics & Real Business Cycles.
- Finn E. Kydland & Edward C. Prescott, 1982. "Executable program for "Time to Build and Aggregate Fluctuations"," QM&RBC Codes 4, Quantitative Macroeconomics & Real Business Cycles.
- Mendoza, Enrique G, 1995. "The Terms of Trade, the Real Exchange Rate, and Economic Fluctuations," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 36(1), pages 101-37, February.
When requesting a correction, please mention this item's handle: RePEc:sce:scecf9:251. 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 references are entirely missing, you can add them using this form.