Two pitfalls of linearization methods

Jinill Kim, Sunghyun Henry Kim

Research output: Contribution to journalShort surveypeer-review

9 Citations (Scopus)

Abstract

This paper illustrates two types of pitfalls when linearization methods are improperly applied. First, if we linearize the constraints before deriving the optimality conditions, the derived conditions are not correct up to first order. Second, even when we obtain the behavior of the economy that is correct to the first order, applying this behavior to welfare implications may lead to incorrect results. We also review different ways to avoid those pitfalls.

Original languageEnglish
Pages (from-to)995-1001
Number of pages7
JournalJournal of Money, Credit and Banking
Volume39
Issue number4
DOIs
Publication statusPublished - 2007 Jun

Keywords

  • Linear-quadratic method
  • Linearization
  • Second-order approximation
  • Welfare

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics

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