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Fundamental shock selection in DSGE models

Ferroni, Filippo and Grassi, Stefano and Leon-Ledesma, Miguel A. (2015) Fundamental shock selection in DSGE models. Working paper. Discussion Papers, School of Economics, University of Kent (KAR id:62893)

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https://ideas.repec.org/p/ukc/ukcedp/1508.html

Abstract

DSGE models are typically estimated assuming the existence of certain structural shocks that drive macroeconomic fluctuations. We analyze the consequences of introducing nonfundamental shocks for the estimation of DSGE model parameters and propose a method to select the structural shocks driving uncertainty. We show that forcing the existence of non-fundamental structural shocks produces a downward bias in the estimated internal persistence of the model. We then show how these distortions can be reduced by allowing the covariance matrix of the structural shocks to be rank deficient using priors for standard deviations whose support includes zero. The method allows us to accurately select fundamental shocks and estimate model parameters with precision. Finally, we revisit the empirical evidence on an industry standard medium-scale DSGE model and find that government, price, and wage markup shocks are non-fundamental.

Item Type: Monograph (Working paper)
Uncontrolled keywords: Reduced rank covariance matrix, DSGE models, stochastic dimension search
Subjects: H Social Sciences > HB Economic Theory
Divisions: Divisions > Division of Human and Social Sciences > School of Economics
Depositing User: Miguel Leon-Ledesma
Date Deposited: 21 Aug 2017 08:32 UTC
Last Modified: 16 Feb 2021 13:47 UTC
Resource URI: https://kar.kent.ac.uk/id/eprint/62893 (The current URI for this page, for reference purposes)
Leon-Ledesma, Miguel A.: https://orcid.org/0000-0002-3558-2990
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