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Title: Identifying the Sources of Model Misspecification

Author(s): Atsushi Inoue, Chun-Hung Kuo and Barbara Rossi

Publication Date: September 2014

Keyword(s): DSGE models, empirical macroeconomics and model misspecification

Programme Area(s): International Macroeconomics

Abstract: In this paper we propose empirical methods for detecting and identifying misspecifications in DSGE models. We introduce wedges in a DSGE model and identify potential misspecification via forecast error variance decomposition (FEVD) and marginal likelihood analyses. Our simulation results based on a small-scale DSGE model demonstrate that our method can correctly identify the source of misspecification. Our empirical results show that the medium-scale New Keynesian DSGE model that incorporates features in the recent empirical macro literature is still very much misspecified; our analysis highlights that the asset and labor markets may be the source of the misspecification.

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Bibliographic Reference

Inoue, A, Kuo, C and Rossi, B. 2014. 'Identifying the Sources of Model Misspecification'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=10140