Discussion paper

DP10140 Identifying the Sources of Model Misspecification

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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Citation

Rossi, B and C Kuo (eds) (2014), “DP10140 Identifying the Sources of Model Misspecification”, CEPR Press Discussion Paper No. 10140. https://cepr.org/publications/dp10140