EconPapers    
Economics at your fingertips  
 

Approximation Bias in Linearized Euler Equations

Sydney Ludvigson () and Christina Paxson

No 236, NBER Technical Working Papers from National Bureau of Economic Research, Inc

Abstract: A wide range of empirical applications rely on linear approximations to dynamic Euler equations. Among the most notable of these is the large and growing literature on precautionary saving that examines how consumption growth and saving behavior are affected by uncertainty and prudence. 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. This literature has produced puzzling results: Estimates of the coefficient of relative prudence (and the coefficient of relative risk aversion) from regressions of consumption growth on uncertainty in consumption growth imply estimates of prudence and risk aversion that are unrealistically low. Using numerical solutions to a fairly standard intertemporal optimization problem, our 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. We also present Monte Carlo evidence that shows that the instrumental variables methods commonly used to estimate the parameters correct some, but not all, of the approximation bias.

Date: 1999-03
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7) Track citations by RSS feed

Published as Ludvigson, Sydney and Christina H. Paxson. "Approximation Bias In Linearized Euler Equations," Review of Economics and Statistics, 2001, v83(2,May), 242-256.

Downloads: (external link)
http://www.nber.org/papers/t0236.pdf (application/pdf)

Related works:
Journal Article: Approximation Bias In Linearized Euler Equations (2001) Downloads
Working Paper: Approximation bias in linearized Euler equations (1997) Downloads
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:nbr:nberte:0236

Ordering information: This working paper can be ordered from
http://www.nber.org/papers/t0236

Access Statistics for this paper

More papers in NBER Technical Working Papers from National Bureau of Economic Research, Inc National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.. Contact information at EDIRC.
Bibliographic data for series maintained by ().

 
Page updated 2019-10-15
Handle: RePEc:nbr:nberte:0236