A Note on the Identification of Dynamic Economic Models with Generalized Shock Processes
| Published date | 01 June 2016 |
| DOI | http://doi.org/10.1111/obes.12115 |
| Date | 01 June 2016 |
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©2015 The Department of Economics, University of Oxford and JohnWiley & Sons Ltd.
OXFORD BULLETIN OF ECONOMICSAND STATISTICS, 78, 3 (2016) 0305–9049
doi: 10.1111/obes.12115
A Note on the Identification of Dynamic Economic
Models with Generalized Shock Processes*
Claire A. Reicher†
†Institut f¨ur Weltwirtschaft, Kiellinie 66, 24105 Kiel, Germany (e-mail: claire.reicher@
ifw-kiel.de)
Abstract
Dynamic stochastic general equilibrium (DSGE) models with generalized shock processes,
such as shock processes which follow a vector autoregression (VAR), have been an active
area of research in recent years. Unfortunately, the structural parameters governing DSGE
models are not identified when the driving process behind the model followsan unrestricted
VAR. This finding implies that parameter estimates derivedfrom recent attempts to estimate
DSGE models with generalized driving processes should be treated with caution, and that
there alwaysexists a tradeoff between identification and the risk of model misspecification.
However, these results also make it easier to address the issue of model misspecification
by making it computationally easier to check the validity of cross-equation restrictions.
I. Introduction
The estimation of dynamic models which feature generalized shock processes has become
an active area of research in recent years. This research is motivated by the intuitively
appealing idea that the orthogonality restrictions typically placed on shocks in Dynamic
stochastic general equilibrium (DSGE) models are arbitrary and restrictive, and that these
restrictions carry with them a risk for misspecification. Toaddress this issue, Ireland (2004)
looks at a model with observation errors which follow a VAR(1), while C ´urdia and Reis
(2012) use Bayesianmethods to estimate a large-scale dynamic model whose shock process
follows a VAR(1). This set of approaches is in contrast with most estimation exercises,
such as that of Smets and Wouters (2007); these exercises have typically relied upon
stronger restrictions upon the underlying shock processes. This contrast is important, since
both Ireland (2004) and C´urdia and Reis (2012) present results which suggest substantial
differences between their estimates and those of Smets and Wouters (2007), which those
authors attribute to the more general nature of their estimated shock processes. Implicit in
JEL Classification numbers: C13, C32, E00
*I thank Steffen Ahrens, Martin Pl¨odt, Jens Boysen-Hogrefe, Dominik Groll, VincenzoCaponi, Henning Weber,
Ignat Stepanok, seminar participants at the IfW, conference participants at the Verein f¨ur Sozialpolitik, Francesco
Zanetti, and two anonymousreferees for their patient advice and valuable feedback. Frank Schorfheide has also made
valuable comments. All remaining errors are mine.
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