TY - JOUR
AU - Nelson,Charles R.
AU - Kim,Chang-Jin
TI - The Time-Varying-Parameter Model as an Alternative to ARCH for Modeling Changing Conditional Variance: The Case of Lucas Hypothesis
JF - National Bureau of Economic Research Technical Working Paper Series
VL - No. 70
PY - 1988
Y2 - September 1988
DO - 10.3386/t0070
UR - http://www.nber.org/papers/t0070
L1 - http://www.nber.org/papers/t0070.pdf
N1 - Author contact info:
Charles Nelson
Department of Economics
University of Washington
Seattle, WA 93195
E-Mail: cnelson@u.washington.edu
AB - The main econometric issue in testing the Lucas hypothesis (1973) in a times series context is the estimation of the variance conditional on past information. The ARCH model, proposed by Engle (1982), is one way of specifying the conditional variance. But the assumption underlying the ARCH specification is ad-hoc. The existence of ARCH can sometimes be interpreted as evidence of misspecification. Under the assumption that a monetary policy regime is continuously changing, a time-varying-parameter (TVP) model is proposed for the monetary growth function. Based on Kalman filtering estimation of recursive forcast errors and their conditional variances, the Lucas hypothesis is tested for the U.S. economy (1964.1 - 1985.4) using monetary growth as an aggregate demand variable. The Lucas hypothesis is rejected in favor of Friedman's (1977) hypothesis: the conditional variance of monetary growth affects real output directly, not through the coefficients on the forcast error term in the Lucas-type output equation.
ER -