Simulation-Based Tests of Forward-Looking Models Under VAR Learning Dynamics

Luca Fanelli () and Giulio Palomba ()

No 298, Working Papers from Universita' Politecnica delle Marche (I), Dipartimento di Scienze Economiche e Sociali

Abstract: In this paper we propose simulation-based techniques to investigate the finite sample performance of likelihood ratio (LR) tests for the nonlinear restrictions that arise when a class of forward-looking (FL) models, typically used in monetary policy analysis, is evaluated with Vector Autoregressive (VAR) models. We consider both `one-shot' tests and sequences of tests under a particular form of adaptive learning dynamics, where `boundedly rational' agents use VARs recursively to update their beliefs. The analysis is based on the comparison of the likelihood of the unrestricted and restricted VAR, and the p-values associated with the LR statistics are computed by Monte Carlo simulation. We also address the case where the variables of the FL model are approximated as non-stationary cointegrated processes. Application to the New Keynesian Phillips Curve in the euro area shows that the FL model of inflation dynamics is not rejected once the suggested simulation-based tests are applied. The result is robust to specification of the VAR as a stationary (albeit highly persistent) or cointegrated system. However, in the second case the imposition of cointegration restrictions changes the estimated degree of price stickiness.

Keywords: Monte Carlo test; VAR; adaptive learning; cross-equation restrictions; forward-looking model; new Keynesian Phillips curve; simulation techniques (search for similar items in EconPapers)
JEL-codes: C12 C32 C52 D83 E10 (search for similar items in EconPapers)
Pages: 27
Date: 2007-09
New Economics Papers: this item is included in nep-cba, nep-ecm and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

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http://docs.dises.univpm.it/web/quaderni/pdf/298.pdf First version, 2007 (application/pdf)

Related works:
Journal Article: Simulation‐based tests of forward‐looking models under VAR learning dynamics (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:anc:wpaper:298

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