Solution of Nonlinear Rational Expectations Models with Applications toFinite-Horizon Life-Cycle Models of Consumption

  • Authors:

  • Michael Binder;M. Hashem Pesaran;S. Hossein Samiei

  • Affiliations:

  • Department of Economics, University of Maryland, Tydings Hall, College Park, MD 20742, U.S.A., E-mail: binder@glue.umd.edu;Faculty of Economics and Politics, University of Cambridge, Sidgwick Avenue, Cambridge, CB3 9DD, U.K., E-mail: hashem.pesaran@econ.cam.ac.uk;International Monetary Fund, 700 19th Street NW, Washington, DC 20431, U.S.A., E-mail: ssamiei@imf.org

  • Venue:
  • Computational Economics - Computational Studies at Stanford
  • Year:
  • 2000

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Abstract

This paper considers the solution of nonlinear rationalexpectations models resulting from the optimality conditions of afinite-horizon intertemporal optimization problem satisfying Bellman'sprinciple of optimality (and possibly involving inequality constraints). Abackward recursive procedure is used to characterize and solve thetime-varying optimal decision rules generally associated with these models.At each stage of these backward recursions, either an analytical ornumerical solution of the optimality conditions is required. When ananalytical solution is not possible, a minimum weighted residual approach isused. The solution technique is illustrated using a life-cycle model ofconsumption under labor income and interest rate uncertainties (and possiblyinvolving liquidity constraints). Approximate numerical solutions areprovided and compared with certainty-equivalent solutions and, whenpossible, with exact solutions.