Inequality Constraints in Recursive Economies
Title: Inequality Constraints in Recursive Economies
Author: RENDAHL, Pontus
Publisher: European University Institute
Series/Number: EUI ECO; 2006/6
Dynamic models with inequality constraints pose a challenging prob- lem for two major reasons: Dynamic Programming techniques often necessitate a non established differentiability of the value function, while Euler equation based techniques have problematic or unknown convergence properties. This paper aims to resolve these two concerns: An \envelope theorem" is presented that establishes the differentiability of any element in the convergent sequence of approximate value functions when inequality constraints may bind. As a corollary, convergence of an iterative procedure on the Euler equation, usually referred to as time iteration, is ascertained. This procedure turns out to be very convenient from a computational perspective; dynamic economic problems with inequality constraints can be solved reliably and extremely e±ciently by exploiting the theoretical insights provided by the paper.
Subject: Inequality constraints; Envelope theorem; Recursive methods; Time iteration
Type of Access: openAccess