Time-Varying Parameter in the Almost Ideal Demand System and the Rotterdam Model: Will the Best Specification Please Stand Up?

Working paper 335
William A. Barnett and Isaac Kalonda-Kanyama
Publication date: 
March, 2013
Applied Economics, 2013

This paper assesses the ability of the Rotterdam model and of three versions of the almost ideal demand system (AIDS) to recover the time-varying elasticities of a true demand system and to satisfy theoretical regularity. Using Monte Carlo simulations, we nd that the Rotterdam model performs better than the linear-approximate AIDS at recovering the signs of all the time-varying elasticities. More importantly, the Rotterdam model has the ability to track the paths of time-varying income elasticities, even when the true values are very high. The linear-approximate AIDS, not only performs poorly at recovering the time-varying elasticities but also badly approximates the nonlinear AIDS.

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