Determinacy, Indeterminacy and Dynamic Misspecification in Linear Rational Expectations Models

Fanelli, Luca (2010) Determinacy, Indeterminacy and Dynamic Misspecification in Linear Rational Expectations Models. Bologna, IT: Dipartimento di Scienze Statistiche "Paolo Fortunati", Alma Mater Studiorum Università di Bologna, p. 40. DOI 10.6092/unibo/amsacta/2871. In: Quaderni di Dipartimento. Serie Ricerche ISSN 1973-9346.
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This paper proposes a testing strategy for the null hypothesis that a multivariate linear rational expectations (LRE) model has a unique stable solution (determinacy) against the alternative of multiple stable solutions (indeterminacy). Under a proper set of identification restrictions, determinacy is investigated by a misspecification-type approach in which the result of the overidentifying restrictions test obtained from the estimation of the LRE model through a version of generalized method of moments is combined with the result of a likelihood-based test for the cross-equation restrictions that the LRE places on its finite order reduced form under determinacy. This approach (i) circumvents the nonstandard inferential problem that a purely likelihood-based approach implies because of the presence of nuisance parameters that appear under the alternative but not under the null, (ii) does not involve inequality parametric restrictions and nonstandard asymptotic distributions, and (iii) gives rise to a joint test which is consistent against indeterminacy almost everywhere in the space of nuisance parameters, i.e. except for a point of zero measure which gives rise to minimum state variable solutions, and is also consistent against the dynamic misspecification of the LRE model. Monte Carlo simulations show that the testing strategy delivers reasonable size coverage and power in finite samples. An empirical illustration focuses on the determinacy/indeterminacy of a New Keynesian monetary business cycle model for the US.

Document type
Monograph (Working Paper)
Fanelli, Luca
Determinatezza, Indeterminatezza, Massima verosimiglianza, Metodo generalizzato dei momenti, Modello lineare con aspettative, Identificazione, Variabili Strumentali, VAR,VARMA Determinacy, Generalized method of moments, Indeterminacy, LRE model, Identification, Instrumental Variables, Maximum Likelihood, VAR, VARMA.
Deposit date
30 Nov 2010 08:58
Last modified
16 May 2011 12:14

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