Flexible Nonlinear Inference with Endogenous Explanatory Variables

Dong Heon Kim

Professor, Department of Economics, Korea University, 145 Anam-ro, Seongbuk-Gu, Seoul, 136-701, South Korea, Tel: +82 2 3290 2226, Fax: +82 2 3290 2661 dongkim@korea.ac.kr

JEL Classification: C13, C32

Abstract

Hamilton’s (2001) flexible nonlinear inference is not valid with endogenous explanatory variables. Hence, this paper proposes a framework to approach endogeneity problems in the flexible nonlinear inference. We develop two estimation procedures, namely, joint estimation and two-step estimation procedures. The parameters in both models can be estimated by maximum likelihood or numerical Bayesian method. Our approach can be used in handling endogeneity and nonlinearity in the oil-macro relationship or in the monetary policy rule.

Keywords:

Control function approach, Endogeneity, Nonlinear flexible inference, Two-step procedure

Acknowledgments

This work is supported by the National Research Foundation of Korea Grant funded by the Korean Government (NRF-2012S1A5A2A01020228). The author would like to thank the editor, two anonymous referees, James D. Hamilton, Chang-Jin Kim, and Sang-Soo Park for their constructive comments. The Korea University Research Grant is also acknowledged.

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