Estimating Euler Equations

Orazio Attanasio and Hamish Low

No 253, NBER Technical Working Papers from National Bureau of Economic Research, Inc

Abstract: In this paper we consider conditions under which the estimation of a log-linearized Euler equation for consumption yields consistent estimates of the preference parameters. When utility is isoelastic and a sample covering a long time period is available, consistent estimates are obtained from the log-linearized Euler equation when the innovations to the conditional variance of consumption growth are uncorrelated with the instruments typically used in estimation. We perform a Montecarlo experiment, consisting in solving and simulating a simple life cycle model under uncertainty, and show that in most situations, the estimates obtained from the log-linearized equation are not systematically biased. This is true even when we introduce heteroscedasticity in the process generating income. The only exception is when discount rates are very high (47% per year). This problem arises because consumers are nearly always close to the maximum borrowing limit: the estimation bias is unrelated to the linearization. Finally, we plot life cycle profiles for the variance of consumption growth, which, except when the discount factor is very high, is remarkably flat. This implies that claims that demographic variables in log-linearized Euler equations capture changes in the variance of consumption growth are unwarranted.

JEL-codes: E2 (search for similar items in EconPapers)
Date: 2000-05
Note: TWP
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (22)

Published as Attanasio, Orazio P. and Hamish Low. "Estimating Euler Equations," Review of Economic Dynamics, 2004, v7(2,Apr), 406-435.

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Journal Article: Estimating Euler Equations (2004)
Working Paper: Estimating Euler equations (2002)
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