Abstract
Abstract This paper is concerned with the solution and estimation of a simple class of linear rational expectations models with current expectations of the endogenous variables when there are a priori bounds on the dependent variable. We show that for plausible values of the parameters, the model has a unique RE solution. We first consider the exact maximum likelihood estimation of such a limited-dependent rational expectations (LD-RE) model and perform a number of Monte Carlo experiments to shed light on the small sample properties of a number of alternative estimators. The results clearly illustrate the importance of taking proper account of the limited nature of the dependent variable and its expectations in the estimation of the parameters of the LD-RE models. We then extend the analysis to a two-limit situation where the dependent variable is within a band, prove the existence and uniqueness of the RE equilibrium for this case, and present an empirical application to the Deutsche mark/French franc exchange rate within the Exchange Rate Mechanism of the European Monetary System.
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