Abstract
In this paper we propose a simple method for estimating and testing the linear quadratic adjustment cost (LQAC) model in the presence of I(1) processes. We specify the LQAC model as an ‘exact’ rational expectations model and we assume that the DGP for the observable variables belongs to the class of cointegrated error correction (ECM) models. By deriving the restrictions implied by the LQAC model on the parameters of the ECM, we propose an alternative econometric technique for the LQAC model. In contrast to existing procedures, we explicitly account for situations where the cointegration rank of the ECM is greater than the number of control variables (i.e. one). The method is applied to the demand for labor in Denmark.
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