Working Paper: NBER ID: w2401
Authors: Melvyn A. Fuss
Abstract: In this note I demonstrate the previously overlooked fact that if the AIDS aggregate demand model is constructed as the aggregation of individual consumer demands, then the error structure for any individual equation is necessarily heteroskedastic unless the distribution of income is constant across aggregates. Maximum likelihood estimation which ignores this heteroskedasticity yields inconsistent estimates of the variance-covariance matrix and renders likelihood ratio tests of the restrictions of consumer demand theory inappropriate. A heteroskedasticity-consistent estimator of the variance-covariance matrix is proposed by adopting the technique of White (1980) to the case at hand.
Keywords: Heteroskedasticity; Demand System; Variance-Covariance Matrix
JEL Codes: C13; D12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Income distribution (D31) | Heteroskedasticity (C21) |
| Ignoring heteroskedasticity (C20) | Inconsistent variance-covariance estimates (C51) |
| Heteroskedasticity (C21) | Validity of likelihood ratio tests (C52) |