The Time-Varying-Parameter Model as an Alternative to ARCH for Modeling Changing Conditional Variance: The Case of Lucas Hypothesis / Charles R. Nelson, Chang-Jin Kim.

Format:

Book

Author/Creator:

Nelson, Charles R.

Contributor:

National Bureau of Economic Research.

Kim, Chang-Jin.

Series:

Technical Working Paper Series (National Bureau of Economic Research) no. t0070.

NBER technical working paper series no. t0070

Language:

English

Subjects (All):

Liquidity (Economics).

Physical Description:

1 online resource: illustrations (black and white);

Other Title:

The Time-Varying-Parameter Model as an Alternative to ARCH for Modeling Changing Conditional Variance

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 1988.

Cambridge, Massachussetts : National Bureau of Economic Research, [1988]

Summary:

The main econometric issue in testing the Lucas hypothesis (1973) in a times series context is the estimation of the variance conditional on past information. The ARCH model, proposed by Engle (1982), is one way of specifying the conditional variance. But the assumption underlying the ARCH specification is ad-hoc. The existence of ARCH can sometimes be interpreted as evidence of misspecification. Under the assumption that a monetary policy regime is continuously changing, a time-varying-parameter (TVP) model is proposed for the monetary growth function. Based on Kalman filtering estimation of recursive forcast errors and their conditional variances, the Lucas hypothesis is tested for the U.S. economy (1964.1 - 1985.4) using monetary growth as an aggregate demand variable. The Lucas hypothesis is rejected in favor of Friedman's (1977) hypothesis: the conditional variance of monetary growth affects real output directly, not through the coefficients on the forcast error term in the Lucas-type output equation.

Notes:

Print version record

September 1988.