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NBER Working Papers and Publications
|October 2005||Convergence Properties of the Likelihood of Computed Dynamic Models|
with Jesus Fernandez-Villaverde, Manuel Santos: t0315
This paper studies the econometrics of computed dynamic models. Since these models generally lack a closed-form solution, their policy functions are approximated by numerical methods. Hence, the researcher can only evaluate an approximated likelihood associated with the approximated policy function rather than the exact likelihood implied by the exact policy function. What are the consequences for inference of the use of approximated likelihoods? First, we find conditions under which, as the approximated policy function converges to the exact policy, the approximated likelihood also converges to the exact likelihood. Second, we show that second order approximation errors in the policy function, which almost always are ignored by researchers, have first order effects on the likelihood funct...
Published: Fernández-Villaverde, Jesus, Juan F. Rubio-Ramírez, and Manuel S. Santos. "Convergence Properties of the Likelihood of Computed Dynamic Models." Econometrica 74, 1 (2006): 93-119.