Convergence Properties of the Likelihood of Computed Dynamic Models / Jesus Fernandez-Villaverde, Juan Rubio, Manuel Santos.

Format:

Book

Author/Creator:

Fernandez-Villaverde, Jesus.

Contributor:

National Bureau of Economic Research.

Rubio, Juan.

Santos, Manuel.

Series:

Technical Working Paper Series (National Bureau of Economic Research) no. t0315.

NBER technical working paper series no. t0315

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2005.

Summary:

This paper studies the econometrics of computed dynamic models. Since these models generally lack a closed-form solution, their policy functions are approximated by numerical methods. Hence, the researcher can only evaluate an approximated likelihood associated with the approximated policy function rather than the exact likelihood implied by the exact policy function. What are the consequences for inference of the use of approximated likelihoods? First, we find conditions under which, as the approximated policy function converges to the exact policy, the approximated likelihood also converges to the exact likelihood. Second, we show that second order approximation errors in the policy function, which almost always are ignored by researchers, have first order effects on the likelihood function. Third, we discuss convergence of Bayesian and classical estimates. Finally, we propose to use a likelihood ratio test as a diagnostic device for problems derived from the use of approximated likelihoods.

Notes:

Print version record

October 2005.