Solving, estimating, and testing a nonlinear stochastic equilibrium model, with an example of the asset returns and inflation relationship

Abstract This paper describes a method for solving, estimating, and testing a fully specified nonlinear stochastic equilibrium model, by simulation. A nonlinear stochastic asset pricing model with production and money is formulated, which aims to explain observed empirical relations between inflation and asset returns. Complete solution paths to the equilibrium model are generated through a backwards-mapping method. The parameters of the model are estimated by simulation taking account of the broad range of dynamics of the model, and overidentifying restrictions of the model are tested by extending GMM procedures.

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