Dynamic Asymptotically Ideal Models and Finite Approximation

Abstract

We extend Barnett and Jonas's asymptotically ideal model (AIM) to model for the possibility that the data were generated by a dynamic process. Prediction errors for dynamic and static AIM models are compared for various simulated datasets. Monetary data are also used to evaluate the AIM specifications. There is substantial evidence that an AR(1) correction considerably improves the quality of low-order finite approximations of AIM with the cost of estimating only one additional parameter. Furthermore, restricting a dynamic AIM to approximate only linear homogenous functions often results in severe misspecification.

KEY WORDS:

• Globally flexible form
• Money demand system
• Seminonparametric