Frequentist Evaluation of Small DSGE Models

The empirical assessment of the NK-DSGE model is based on a conditional sequence of likelihood-based tests conducted in a Vector Autoregressive (VAR) system, in which both the low and high frequency implications of the model are addressed in a coherent framework.

If the low frequency behavior of the original time series of the model can be approximated by non-stationary processes, stationarity must be imposed by removing the stochastic trends. This gives rise to a set of recoverable unit roots/cointegration restrictions, in addition to the short-run cross-equation restrictions. The procedure is based on the sequence ‘LR1→LR2→LR3’, where LR1 is the cointegration rank test, LR2 the cointegration matrix test and LR3 the cross-equation restrictions test: LR2 is computed conditional on LR1 and LR3 is computed conditional on LR2.