I have trouble with estimating a simple two country model with a UIP condition. The model works perfectly if I have a perfect international risk sharing condition, however it runs into indeterminacy so often if I switch to a UIP condition, which means an “incomplete financial market” by Chari et al (2004) or Heathcote and Perri (2002). I guess the problem is that a UIP condition introduce an eigenvalue of 1, while exchange rate becomes a forward looking variable if defined in this way. If I do simulation, I can simple set qz_criterium=.99 or something (It might be cheating), but I don’t know how to do it in the estimation procedure.
There seem to be quite a few papers estimating open models with incomplete market, and I would appreciate if anyone can share me the tricks working around the indeterminacy issue.
Thanks in advance.