Simultaneous Equation Models
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Transcript Simultaneous Equation Models
Simultaneous Equation Models
class notes by Prof. Vinod
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Marshallian Demand Supply
• No equilibrium unless we consider both
equations. Estimate simultaneously
• Two equation macro equilibrium. MPC
overestimated even asymptotically T
• Structure has 2 equations and so does
reduced form.
• Prove that OLS is inconsistent
• Successively weaker assumptions
If not OLS what? Reduced Form?
• ILS, 2SLS, 3SLS,LIML, FIML, Reduced
Rank regression (see T.W.Anderson, 2000)
• Rewrite the 2 equation Macro model
without the intercept in matrix notation.
• Structure is Y +XB =U, post multiply
• Y1 +XB1 =U1
• Y=X+V change notation
Variable Types
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Jointly dependent (prices, quantities) (Y,C)
Exogenous (rainfall, GNP) (Investment)
Assumptions of SimEqModels
Included Endog mj, Excluded Endog mj*
Included Exog Kj, Excluded exog Kj*
Rewrite the structure one eq at a time
j-th eq. Is Identified if Kj* > mj
Identification
• Demand eq. identified if it has a unique
variable (GNP) excluded in the supply eq.
• Supply eq. is identified it it has another
unique variable (rainfall) excluded from the
demand equation.
• Formally identification means going from
reduced form to the structure. (in general
impossible since too many unknowns)
Proper Identification catches the
imposter models
• Greene Ed4 p.665 has imposter model
where one simply post-multiplies the
structure by a nonsingular matrix F
• YF +XBF =UF. The reduced form is still
the same: FF1 cancels out as identity mtx.
• YFF11 +XBFF11 =UFF11
Y=X+V (rank and order conditions)
Algebra of Identification
• We want to estimate structural parameters and B
from reduced form . Start with the definition of
reduced form
B 1= split them in 3 parts and derive
21 = 21 1 Note small and big are different,
conformable matrix multiplication is involved.
Star means excluded variable, but we need to keep
them with zero coefficients to do the algebra.
Rank of 21 =min(K1*, m1) has to be > m1, i.e. we
must exclude enough variables (rainfall absent in
Demand eq. Is order condition)
Identification (nonsample info),
Recursive Models
• Instead of exclusion restriction (coeff=zero)
some coefficients may be fixed at some
specific and this too can help identification.
• Wold recursive models y1=f(x), y2=f(y1,x)
y3=f(y1,y2,x), y4=f(y1,y2,y3,x). OLS is OK on
one equation at a time (this is called limited
information estimation)
Instrumental variable estimation
• Instruments must be uncorrelated with
errors and correlated with the variables
being instrumented out! 2SLS uses
predicted Y as instrument. If the weighting
matrix is (X’X)-1 then GenMethM=2SLS
• Limited information methods (one eq at a
time) versus full information methods (all
together simultaneously in a GLS scheme)
Maximum Likelihood estimation
• This involves least variance ratio, the
smallest eigenvalue (characteristic root) in
the limited info case (LIML) and if all
equations are written together it is FIML.
• Full info formulation often involves the
Kronecker product of matrices.
k-class estimator
• Insert a k in the 2SLS partitioned matrix in
the top left corner before V’V in the 2 by 2
matrix and the same k before V’v in the top
of the 2 by 1 vector [2SLS has k=1]
• Let the k take different values to define a
class of estimators. Even LIML becomes a
special case k=eigenvalue, for OLS, k=0
Testing overidentifying restrictions
• Hausman test of specification of x as exog
• Null hyp: x is exog and both d and d* are
consistent but only d* is asymptotically effi.
• Under Alternative hyp x is actually endog, d
is consistent and d* is inconsistent (rquires
an arbitrary choice of some eq. Which does
not contain x It is quadratic form in (d-d*)