Simulation Based Inference in Simultaneous Equations

Abstract

In the context of multivariate regression (MLR) and simultaneous equations (SE), it is well known that commonly employed asymptotic test criteria are seriously biased towards over-rejection. In this paper, we propose exact likelihood based tests for possibly nonlinear hypotheses on the coefficients of SE systems. We discuss a number of bounds tests and Monte Carlo simulation based tests. The latter involves maximizing a randomized p-value function over the relevant nuisance parameter space which is done numerically by using a simulated annealing algorithm. We consider limited and full information models, in which case we introduce a multi-equation Anderson-Rubin-type test. Illustrative Monte Carlo experiments show that: (i) bootstrapping standard instrumental variable (IV) based criteria fails to achieve size control, especially (but not exclusively) under near non-identification conditions, and (ii) the tests based on IV estimates do not appear to be boundedly pivotal and so no size-correction may be feasible. By contrast, likelihood ratio based tests work well in the experiments performed.