Firm's R&D Behavior Under Rational Expectations

This paper formulates the intertemporal R&D investment decision problem of private firms within an optimal stochastic control framework. The paper derives explicitly the R&D investment decision rule and the cross equations parameter restrictions imposed by the hypothesis of rational expectations, using the Riccati equation only and not requiring the Wiener-Kolmogorov prediction formula. Identification and estimation of the structural parameters are essential for evaluating policies to be free from Lucas critique. The paper finds conditions under which the structural parameters are identified and then discusses econometric procedures for estimating the structural parameters, and testing the model