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Keywords:Linear models (Statistics) 

Working Paper
Two pitfalls of linearization methods

This paper illustrates two types of pitfalls in using linearization methods. First, if constraints are linearized before deriving optimality conditions, the derived conditions are not correct up to first order. Second, even when the behavior of the economy is correct to the first order, applying this behavior to welfare implications may lead to incorrect results.
Finance and Economics Discussion Series , Paper 2007-64

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