Department of Economics and Business Economics

Ensuring the Validity of the Micro Foundation in DSGE Models

Research output: Working paperResearch

  • Martin Møller Andreasen, Denmark
  • School of Economics and Management
The presence of i) stochastic trends, ii) deterministic trends, and/or iii) stochastic volatil-
ity in DSGE models may imply that the agents' objective functions attain infinite values. We
say that such models do not have a valid micro foundation. The paper derives sufficient condi-
tions which ensure that the objective functions of the households and the firms are finite even
when various trends and stochastic volatility are included in a standard DSGE model. Based
on these conditions we test the validity of the micro foundation in six DSGE models from
the literature. The models of Justiniano & Primiceri (American Economic Review, forth-
coming) and Fernández-Villaverde & Rubio-Ramírez (Review of Economic Studies, 2007) do
not satisfy these sufficient conditions, or any other known set of conditions ensuring finite
values for the objective functions. Thus, the validity of the micro foundation in these models
remains to be established.
Original languageEnglish
Place of publicationAarhus
PublisherInstitut for Økonomi, Aarhus Universitet
Number of pages43
Publication statusPublished - 2008

    Research areas

  • Deterministic trends, DSGE models, Error distributions, Moment generating functions, Stochastic trends, Stochastic volatility, Unit-roots

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ID: 11426521