TY - JOUR
AU - Attanasio, Orazio P
AU - Low, Hamish
TI - Estimating Euler Equations
JF - National Bureau of Economic Research Technical Working Paper Series
VL - No. 253
PY - 2000
Y2 - May 2000
DO - 10.3386/t0253
UR - http://www.nber.org/papers/t0253
L1 - http://www.nber.org/papers/t0253.pdf
N1 - Author contact info:
Orazio Attanasio
Department of Economics
Yale University
37 Hillhouse Avenue
New Haven, CT 06511
E-Mail: orazio.attanasio@yale.edu
Hamish Low
Department of Economics
University of Oxford
Oxford England
E-Mail: hamish.low@economics.ox.ac.uk
AB - 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.
ER -