Empirical policy functions as benchmarks for evaluation of dynamic models

Bazdresch, Santiago and Kahn, R. Jay and Whited, Toni (2011): Empirical policy functions as benchmarks for evaluation of dynamic models.

Abstract

We describe a set of model-dependent statistical benchmarks that can be used to estimate and evaluate dynamic models of firms' investment and financing. The benchmarks characterize the empirical counterparts of the models' policy functions. These empirical policy functions (EPFs) are intuitively related to the corresponding model, their features can be estimated very easily and robustly, and they describe economically important aspects of firms' dynamic behavior. We calculate the benchmarks for a traditional trade-off model using Compustat data and use them to estimate some of its parameters. We present two Monte Carlo exercises, one that shows EPF-based estimation has lower average bias and lower variance than traditional moment-based estimation and another that shows EPF-based tests are better at detecting misspecification.

• Item Type: MPRA Paper
• Language: English
• Keywords: trade-off model,structural models of capital structure, estimation of dynamic models, indirect inference, model evaluation
• Subjects: C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods and Methodology: General > C14 - Semiparametric and Nonparametric Methods: General; C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C52 - Model Evaluation, Validation, and Selection; C - Mathematical and Quantitative Methods > C6 - Mathematical Methods ; Programming Models ; Mathematical and Simulation Modeling > C61 - Optimization Techniques ; Programming Models ; Dynamic Analysis; G - Financial Economics > G3 - Corporate Finance and Governance > G31 - Capital Budgeting ; Fixed Investment and Inventory Studies ; Capacity; G - Financial Economics > G3 - Corporate Finance and Governance > G32 - Financing Policy ; Financial Risk and Risk Management ; Capital and Ownership Structure ; Value of Firms ; Goodwill

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