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MODEL DISCOVERY AND TRYGVE HAAVELMO’S LEGACY

  • David F. Hendry (a1) and Søren Johansen (a2)
Abstract

Trygve Haavelmo’s Probability Approach aimed to implement economic theories, but he later recognized their incompleteness. Although he did not explicitly consider model selection, we apply it when theory-relevant variables, {Xt}, are retained without selection while selecting other candidate variables, {Wt}. Under the null that the {Wt} are irrelevant, by orthogonalizing with respect to the {Xt}, the estimator distributions of the Xt’s parameters are unaffected by selection even for more variables than observations and for endogenous variables. Under the alternative, when the joint model nests the generating process, an improved outcome results from selection. This implements Haavelmo’s program relatively costlessly.

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Corresponding author
*Address correspondence to David F. Hendry, Institute for New Economic Thinking, University of Oxford, Eagle House, Walton Well Road, Oxford OX2 6ED, UK. email: david.hendry@nuffield.ox.ac.uk
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