Updating Probabilities: An Econometric Example

TL;DR

This paper demonstrates how the Maximum relative Entropy method can incorporate observable data and moment constraints, providing a practical econometric example and comparing it to large deviation solutions.

Contribution

It introduces a detailed econometric example using ME, serving as a template for real-world problems and highlighting advantages over large deviation methods.

Findings

ME effectively incorporates data and moments

Numerical example shows advantages over large deviation

Template for applying ME in econometrics

Abstract

We demonstrate how information in the form of observable data and moment constraints are introduced into the method of Maximum relative Entropy (ME). A general example of updating with data and moments is shown. A specific econometric example is solved in detail which can then be used as a template for real world problems. A numerical example is compared to a large deviation solution which illustrates some of the advantages of the ME method.