I have a question concerning the Rotemberg pricing model. My issue lies in calibrating the “gamma” parameter, which represents the Rotemberg adjustment cost. I followed Professor Pfeifer’s guidance from a previous post (How to do a calbiration?) for calibrating gamma. After equalizing the slope of the PC, the resulting value for gamma is 49. However, the model fails to run when gamma exceeds a value of 1.2.
To provide some context, I will explain the steps I followed. I replaced the Calvo equations with the Rotemberg equation, as shown below:
Calvo equations: %Y = Z/Delta*L^(1-alpha)*(K(-1)*Omega(-1))^alpha; %1 = theta*(1+pi)^(epsilon-1) + (1-theta)*pstar^(1-epsilon); %pstar = Xi1/Xi2; %Xi1 = epsilon/(epsilon-1)*mu*Y + theta*SDF*(1+pi(+1))^epsilon *Xi1(+1); %Xi2 = Y + theta*SDF*(1+pi(+1))^(epsilon-1)*Xi2(+1); %Delta = (1-theta)*pstar^(-epsilon) + theta*(1+pi)^epsilon*Delta(-1); Rotemberg equation: 1-epsilon+epsilon*mu=gamma*(pi-1)*pi-gamma*SDF*(pi(+1)-1)*pi(+1)*(Y(+1)/Y);
The initial values for the other parameters are as follows:
epsilon = 4.167;
theta = 0.779; % Calvo
beta = 0.995;
Any insight into the potential causes of this problem would be greatly appreciated!