RDP 2011-06: Does Equity Mispricing Influence Household and Firm Decisions? Appendix D: Alternative Identification Strategy

Rather than partitioning the system in Equation (9) according to those variables directly influenced by permanent and transitory shocks, I now partition the system into equity prices (y22t) and other variables Inline Equation. That is,

where again I use six normalisation restrictions on the main diagonal of B0. Using the same methodology as that discussed previously, it is straightforward to verify that provided Inline Equation exists, one can proceed estimating

using zt as an instrument for Δy22t. The estimated reduced-form residuals, comprising both permanent and transitory shocks Inline Equation, can then be used as instruments for Inline Equation in the estimation of

where I have used the conformable partition

The additional restriction that mispricing shocks have only transitory effects, Inline Equation, is not imposed.