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GeneralizedmethodofmomentsWikipedia,thefreeencyclopedia

Generalizedmethodofmoments
FromWikipedia,thefreeencyclopedia

Ineconometrics,thegeneralizedmethodofmoments(GMM)isagenericmethodforestimatingparametersinstatistical
models.Usuallyitisappliedinthecontextofsemiparametricmodels,wheretheparameterofinterestisfinitedimensional,
whereasthefullshapeofthedistributionfunctionofthedatamaynotbeknown,andthereforethemaximumlikelihood
estimationisnotapplicable.
Themethodrequiresthatacertainnumberofmomentconditionswerespecifiedforthemodel.Thesemomentconditionsare
functionsofthemodelparametersandthedata,suchthattheirexpectationiszeroatthetruevaluesoftheparameters.The
GMMmethodthenminimizesacertainnormofthesampleaveragesofthemomentconditions.
TheGMMestimatorsareknowntobeconsistent,asymptoticallynormal,andefficientintheclassofallestimatorsthatdont
useanyextrainformationasidefromthatcontainedinthemomentconditions.
GMMwasdevelopedbyLarsPeterHansenin1982asageneralizationofthemethodofmomentswhichwasintroducedby
KarlPearsonin1894.Hansensharedthe2013NobelPrizeinEconomicsinpartforthiswork.

Contents
1Description
2Properties
2.1Consistency
2.2Asymptoticnormality
2.3Efficiency
3Implementation
4Jtest
5Scope
6Implementations
7Seealso
8References

Description
SupposetheavailabledataconsistsofTobservations{Yt}t=1,...,T,whereeachobservationYtisanndimensionalmultivariate
randomvariable.Weassumethatthedatacomefromacertainstatisticalmodel,defineduptoanunknownparameter.
Thegoaloftheestimationproblemistofindthetruevalueofthisparameter,0,oratleastareasonablycloseestimate.
AgeneralassumptionofGMMisthatthedataYtbegeneratedbyaweaklystationaryergodicstochasticprocess.(Thecaseof
independentandidenticallydistributed(iid)variablesYtisaspecialcaseofthiscondition.)
InordertoapplyGMM,weneedtohave"momentconditions",i.e.weneedtoknowavectorvaluedfunctiong(Y,)suchthat

whereEdenotesexpectation,andYtisagenericobservation.Moreover,thefunctionm()mustdifferfromzerofor0,or
otherwisetheparameterwillnotbepointidentified.
ThebasicideabehindGMMistoreplacethetheoreticalexpectedvalueE[]withitsempiricalanalogsampleaverage:
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andthentominimizethenormofthisexpressionwithrespectto.Theminimizingvalueofisourestimatefor0.
Bythelawoflargenumbers,
forlargevaluesofT,andthusweexpectthat
.The
generalizedmethodofmomentslooksforanumber whichwouldmake
asclosetozeroaspossible.Mathematically,this
isequivalenttominimizingacertainnormof
(normofm,denotedas||m||,measuresthedistancebetweenmandzero).The
propertiesoftheresultingestimatorwilldependontheparticularchoiceofthenormfunction,andthereforethetheoryofGMM
considersanentirefamilyofnorms,definedas

whereWisapositivedefiniteweightingmatrix,andmdenotestransposition.Inpractice,theweightingmatrixWiscomputed
basedontheavailabledataset,whichwillbedenotedas .Thus,theGMMestimatorcanbewrittenas

Undersuitableconditionsthisestimatorisconsistent,asymptoticallynormal,andwithrightchoiceofweightingmatrix also
asymptoticallyefficient.

Properties
Consistency
Consistencyisastatisticalpropertyofanestimatorstatingthat,havingasufficientnumberofobservations,theestimatorwill
getarbitrarilyclosetothetruevalueofparameter:

(seeConvergenceinprobability).NecessaryandsufficientconditionsforaGMMestimatortobeconsistentareasfollows:
1.

whereWisapositivesemidefinitematrix,

2.

onlyfor

3. Thesetofpossibleparameters
4.

iscompact,

iscontinuousateachwithprobabilityone,

5.
Thesecondconditionhere(socalledGlobalidentificationcondition)isoftenparticularlyhardtoverify.Thereexistsimpler
necessarybutnotsufficientconditions,whichmaybeusedtodetectnonidentificationproblem:
Ordercondition.Thedimensionofmomentfunctionm()shouldbeatleastaslargeasthedimensionofparameter
vector.
Localidentification.Ifg(Y,)iscontinuouslydifferentiableinaneighborhoodof

,thenmatrix

musthavefullcolumnrank.
Inpracticeappliedeconometriciansoftensimplyassumethatglobalidentificationholds,withoutactuallyprovingit.[1]

Asymptoticnormality

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Asymptoticnormalityisausefulproperty,asitallowsustoconstructconfidencebandsfortheestimator,andconductdifferent
tests.BeforewecanmakeastatementabouttheasymptoticdistributionoftheGMMestimator,weneedtodefinetwoauxiliary
matrices:

Thenunderconditions16listedbelow,theGMMestimatorwillbeasymptoticallynormalwithlimitingdistribution

(seeConvergenceindistribution).Conditions:
1. isconsistent(seeprevioussection),
2. Thesetofpossibleparameters
3.

iscompact,

iscontinuouslydifferentiableinsomeneighborhoodNof

withprobabilityone,

4.
5.
6. thematrix

isnonsingular.

Efficiency
SofarwehavesaidnothingaboutthechoiceofmatrixW,exceptthatitmustbepositivesemidefinite.Infactanysuchmatrix
willproduceaconsistentandasymptoticallynormalGMMestimator,theonlydifferencewillbeintheasymptoticvarianceof
thatestimator.Itcanbeshownthattaking

willresultinthemostefficientestimatorintheclassofallasymptoticallynormalestimators.Efficiencyinthiscasemeansthat
suchanestimatorwillhavethesmallestpossiblevariance(wesaythatmatrixAissmallerthanmatrixBifBAispositivesemi
definite).
InthiscasetheformulafortheasymptoticdistributionoftheGMMestimatorsimplifiesto

Theproofthatsuchachoiceofweightingmatrixisindeedoptimalisoftenadoptedwithslightmodificationswhenestablishing
efficiencyofotherestimators.Asaruleofthumb,aweightingmatrixisoptimalwheneveritmakesthesandwichformulafor
variancecollapseintoasimplerexpression.
Proof.WewillconsiderthedifferencebetweenasymptoticvariancewitharbitraryWandasymptoticvariancewith
.IfwecanfactorthisdifferenceintoasymmetricproductoftheformCC'forsomematrixC,thenitwill
guaranteethatthisdifferenceisnonnegativedefinite,andthus
willbeoptimalbydefinition.

whereweintroducedmatricesAandBinordertoslightlysimplifynotationIisanidentitymatrix.Wecanseethat
matrixBhereissymmetricandidempotent:
.ThismeansIBissymmetricandidempotentaswell:
.Thuswecancontinuetofactorthepreviousexpressionas

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Implementation
OnedifficultywithimplementingtheoutlinedmethodisthatwecannottakeW=1because,bythedefinitionofmatrix,
weneedtoknowthevalueof0inordertocomputethismatrix,and0ispreciselythequantitywedontknowandaretrying
toestimateinthefirstplace.
Severalapproachesexisttodealwiththisissue,thefirstonebeingthemostpopular:
TwostepfeasibleGMM:
Step1:TakeW=I(theidentitymatrix),andcomputepreliminaryGMMestimate

.Thisestimatorisconsistent

for0,althoughnotefficient.
Step2:Take

wherewehavepluggedinourfirststeppreliminaryestimate

.Thismatrixconvergesinprobabilityto1and

thereforeifwecompute withthisweightingmatrix,theestimatorwillbeasymptoticallyefficient.
IteratedGMM.Essentiallythesameprocedureas2stepGMM,exceptthatthematrix

isrecalculatedseveraltimes.

Thatis,theestimateobtainedinstep2isusedtocalculatetheweightingmatrixforstep3,andsoon.Suchestimator,
denoted

,isequivalenttosolvingthefollowingsystemofequations:[2]

Asymptoticallynoimprovementcanbeachievedthroughsuchiterations,althoughcertainMonteCarloexperiments
suggestthatfinitesamplepropertiesofthisestimatorareslightlybetter.
ContinuouslyUpdatingGMM(CUGMM,orCUE).Estimates simultaneouslywithestimatingtheweightingmatrix
W:

InMonteCarloexperimentsthismethoddemonstratedabetterperformancethanthetraditionaltwostepGMM:the
estimatorhassmallermedianbias(althoughfattertails),andtheJtestforoveridentifyingrestrictionsinmanycaseswas
morereliable.[3]
Anotherimportantissueinimplementationofminimizationprocedureisthatthefunctionissupposedtosearchthrough
(possiblyhighdimensional)parameterspaceandfindthevalueofwhichminimizestheobjectivefunction.Nogeneric
recommendationforsuchprocedureexists,itisasubjectofitsownfield,numericaloptimization.

Jtest
Whenthenumberofmomentconditionsisgreaterthanthedimensionoftheparametervector,themodelissaidtobeover
identified.Overidentificationallowsustocheckwhetherthemodel'smomentconditionsmatchthedatawellornot.

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Conceptuallywecancheckwhether
issufficientlyclosetozerotosuggestthatthemodelfitsthedatawell.TheGMM
methodhasthenreplacedtheproblemofsolvingtheequation
,whichchooses tomatchtherestrictionsexactly,
byaminimizationcalculation.Theminimizationcanalwaysbeconductedevenwhenno existssuchthat
.This
iswhatJtestdoes.TheJtestisalsocalledatestforoveridentifyingrestrictions.
Formallyweconsidertwohypotheses:
(thenullhypothesisthatthemodelisvalid),and
(thealternativehypothesisthatmodelisinvalidthedatadonotcomeclosetomeeting
therestrictions)
Underhypothesis
be:

,thefollowingsocalledJstatisticisasymptoticallychisquaredwithkldegreesoffreedom.DefineJto

under
where istheGMMestimatoroftheparameter ,kisthenumberofmomentconditions(dimensionofvectorg),andlisthe
numberofestimatedparameters(dimensionofvector).Matrix
mustconvergeinprobabilityto
,theefficient
weightingmatrix(notethatpreviouslyweonlyrequiredthatWbeproportionalto
forestimatortobeefficienthoweverin
ordertoconducttheJtestWmustbeexactlyequalto
,notsimplyproportional).
Underthealternativehypothesis

,theJstatisticisasymptoticallyunbounded:

under
ToconductthetestwecomputethevalueofJfromthedata.Itisanonnegativenumber.Wecompareitwith(forexample)the
0.95quantileofthe
distribution:
isrejectedat95%confidencelevelif
cannotberejectedat95%confidencelevelif

Scope
ManyotherpopularestimationtechniquescanbecastintermsofGMMoptimization:
OrdinaryLeastSquares(OLS)isequivalenttoGMMwithmomentconditions:

GeneralizedLeastSquares(GLS)

Instrumentalvariablesregression(IV)

NonlinearLeastSquares(NLLS):

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Maximumlikelihoodestimation(MLE):

Implementations
RProgrammingwikibook,MethodofMoments(http://en.wikibooks.org/wiki/R_Programming/Method_of_Moments)
R(http://cran.rproject.org/web/packages/gmm/gmm.pdf)
Stata(http://www.stata.com/help.cgi?gmm)
EViews(http://www.eviews.com/EViews7/ev7features.html)

Seealso
Methodofmaximumlikelihood
Generalizedempiricallikelihood

References
1. ^Newey,McFadden(1994),p.2127
2. ^Imbens,Spady&Johnson(1998,p.336)
3. ^Hansen,Heaton&Yaron(1996)
KirbyFaciane(2006):StatisticsforEmpiricalandQuantitativeFinance.H.C.Baird:Philadelphia.ISBN0978820894.
AlastairR.Hall(2005).GeneralizedMethodofMoments(AdvancedTextsinEconometrics).OxfordUniversityPress.ISBN019
8775202.
Hansen,LarsPeter(1982)."LargeSamplePropertiesofGeneralizedMethodofMomentsEstimators".Econometrica50(4):1029
1054.JSTOR1912775(https://www.jstor.org/stable/1912775).
LarsPeterHansen(2002):MethodofMomentsinInternationalEncyclopediaoftheSocialandBehaviorSciences,N.J.SmelserandP.
B.Bates(editors),Pergamon:Oxford.
Hansen,LarsPeterHeaton,JohnYaron,Yaron(1996)."FinitesamplepropertiesofsomealternativeGMMestimators".Journalof
Business&EconomicStatistics14(3):262280.doi:10.1080/07350015.1996.10524656
(https://dx.doi.org/10.1080%2F07350015.1996.10524656).JSTOR1392442(https://www.jstor.org/stable/1392442).
Imbens,GuidoW.Spady,RichardH.Johnson,Phillip(1998)."Informationtheoreticapproachestoinferenceinmomentcondition
models".Econometrica66(2):333357.JSTOR2998561(https://www.jstor.org/stable/2998561).
NeweyW.,McFaddenD.(1994).Largesampleestimationandhypothesistesting,inHandbookofEconometrics,Ch.36.Elsevier
Science.
SpecialissuesofJournalofBusinessandEconomicStatistics:vol.14,no.3(http://www.jstor.org/stable/i260360)andvol.20,no.4
(http://pubs.amstat.org/toc/jbes/20/4).

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