When should one consider using GMM?

One of the things which makes econometrics unique is the use of the Generalized Method of Moments technique.

What types of problems make GMM more appropriate than other estimation techniques? What does using GMM buy you in terms of efficiency or reduced bias or more specific parameter estimation?

Conversely, what do you lose by using GMM over MLE, etc.?

Answer

The implications of economic theories are often naturally formulated in terms of conditional moment restrictions (see e.g. the original asset pricing application of LP Hansen) which nest a variety of unconditional restrictions thus leading to overidentification. Rather than arbitrarily picking “which squares to minimize” to satisfy a subset of those restriction exactly using whatever-LS, GMM provides a way of efficiently combining all of them.

MLE requires a complete specification – all of the moments of all the random variables included in the model should be matched. If those additional restrictions are satisfied in the population, you are naturally getting a more efficient estimator, perhaps, with a better behaving objective function to be optimized.

In the context of simulation estimation, however, nonlinearity of likelihood functions introduces an additional source of bias, complicating the comparison with SMM.

Attribution
Source : Link , Question Author : Ari B. Friedman , Answer Author : Alex

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