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| Author: | Ludvigson, S. Paxson, C. H. |
| Title: | Approximation bias in linearized Euler equations |
| Journal: | Review of Economics and Statistics
2001 : MAY, VOL. 83:2, p. 242-256 |
| Index terms: | CONSUMPTION GROWTH OPTIMIZATION |
| Language: | eng |
| Abstract: | Linear approximations to Euler equations imply a linear relationship between expected consumption growth and uncertainty in consumption growth, with a slope coefficient that is a function of the coefficient of relative prudence. Using numerical solutions to a fairly standard intertemporal optimization problem, the authors' results show that the actual relationship between expected consumption growth and uncertainty in consumption growth differs substantially from the relationship implied by a linear approximation. The authors also present Monte Carlo evidence that shows that the instrumental-variables methods that are commonly used to estimate the parameters correct some, but not all, of the approximation bias. |
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