Comparing Indirect Inference and Likelihood Testing: Asymptotic and Small Sample Results

20 Pages Posted: 18 Aug 2015

See all articles by David Meenagh

David Meenagh

Cardiff University Business School

Patrick Minford

Cardiff University Business School; Centre for Economic Policy Research (CEPR)

Michael Wickens

University of York; Cardiff Business School; Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute)

Yongdeng Xu

Cardiff University - Cardiff Business School - Economics Section

Date Written: August 2015

Abstract

Indirect Inference has been found to have much greater power than the Likelihood Ratio in small samples for testing DSGE models. We look at asymptotic and large sample properties of these tests to understand why this might be the case. We find that the power of the LR test is undermined when re-estimation of the error parameters is permitted; this offsets the effect of the falseness of structural parameters on the overall forecast error. Even when the two tests are done on a like-for-like basis Indirect Inference has more power because it uses the distribution restricted by the DSGE model being tested.

Keywords: DSGE model, error processes, indirect inference, likelihood ratio, structural parameters

JEL Classification: C12, C32, C52, E1

Suggested Citation

Meenagh, David and Minford, Patrick and Wickens, Michael and Xu, Yongdeng, Comparing Indirect Inference and Likelihood Testing: Asymptotic and Small Sample Results (August 2015). CEPR Discussion Paper No. DP10765. Available at SSRN: https://ssrn.com/abstract=2645718

David Meenagh (Contact Author)

Cardiff University Business School ( email )

Aberconway Building
Colum Drive
Cardiff, CF10 3EU
United Kingdom
+44 29 2087 5198 (Phone)
+44 29 2087 4419 (Fax)

Patrick Minford

Cardiff University Business School ( email )

Aberconway Building
Colum Drive
Cardiff, CF10 3EU
United Kingdom
+44 29 2087 5728 (Phone)
+44 29 2087 4419 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Michael Wickens

University of York ( email )

Heslington
York, YO10 5DD
United Kingdom
+44 1904 433 764 (Phone)
+44 1904 433 575 (Fax)

Cardiff Business School ( email )

Centre for Economic Policy Research (CEPR)

London
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Yongdeng Xu

Cardiff University - Cardiff Business School - Economics Section ( email )

Cardiff CF10 3EU
United Kingdom

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