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Discretization of highly persistent correlated AR(1) shocks

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  • Galindev, Ragchaasuren
  • Lkhagvasuren, Damba

Abstract

The finite state Markov-chain approximation methods developed by Tauchen (1986) and Tauchen and Hussey (1991) are widely used in economics, finance and econometrics to solve functional equations in which state variables follow autoregressive processes. For highly persistent processes, the methods require a large number of discrete values for the state variables to produce close approximations which leads to an undesirable reduction in computational speed, especially in a multivariate case. This paper proposes an alternative method of discretizing multivariate autoregressive processes. This method can be treated as an extension of Rouwenhorst's (1995) method which, according to our finding, outperforms the existing methods in the scalar case for highly persistent processes. The new method works well as an approximation that is much more robust to the number of discrete values for a wide range of the parameter space.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 34 (2010)
Issue (Month): 7 (July)
Pages: 1260-1276

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Handle: RePEc:eee:dyncon:v:34:y:2010:i:7:p:1260-1276

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Keywords: Finite state Markov-chain approximation Discretization of multivariate autoregressive processes Transition matrix Numerical methods Value function iteration;

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  1. Mortensen, Dale T & Pissarides, Christopher A, 1994. "Job Creation and Job Destruction in the Theory of Unemployment," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 61(3), pages 397-415, July.
  2. Lu Zhang, 2005. "The Value Premium," Journal of Finance, American Finance Association, vol. 60(1), pages 67-103, 02.
  3. Edward S. Knotek II & Stephen Terry, 2008. "Markov-chain approximations of vector autoregressions: application of general multivariate-normal integration techniques," Research Working Paper, Federal Reserve Bank of Kansas City RWP 08-02, Federal Reserve Bank of Kansas City.
  4. Karen A. Kopecky & Richard M. H. Suen, 2009. "Finite State Markov-Chain Approximations to Highly Persistent Processes," Working Papers 200904, University of California at Riverside, Department of Economics, revised May 2009.
  5. Flodén, Martin, 2008. "A note on the accuracy of Markov-chain approximations to highly persistent AR(1) processes," Economics Letters, Elsevier, vol. 99(3), pages 516-520, June.
  6. Tauchen, George, 1986. "Finite state markov-chain approximations to univariate and vector autoregressions," Economics Letters, Elsevier, vol. 20(2), pages 177-181.
  7. Tauchen, George & Hussey, Robert, 1991. "Quadrature-Based Methods for Obtaining Approximate Solutions to Nonlinear Asset Pricing Models," Econometrica, Econometric Society, Econometric Society, vol. 59(2), pages 371-96, March.
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Citations

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Cited by:
  1. Kopecky, Karen A. & Suen, Richard M. H., 2009. "Finite State Markov-Chain Approximations to Highly Persistent Processes," MPRA Paper 15122, University Library of Munich, Germany.
  2. Paul Gomme & Damba Lkhagvasuren, 2013. "The Cyclicality of Search Intensity in a Competitive Search Model," Working Papers, Concordia University, Department of Economics 13002, Concordia University, Department of Economics, revised Sep 2013.
  3. Damba Lkhagvasuren, 2005. "Big Locational Differences in Unemployment Despite High Labor Mobility," Working Papers, Concordia University, Department of Economics 12002, Concordia University, Department of Economics, revised Feb 2012.
  4. Zhao, Yan, 2011. "Borrowing constraints and the trade balance-output comovement," MPRA Paper 36902, University Library of Munich, Germany.
  5. Gospodinov, Nikolay & Lkhagvasuren, Damba, 2011. "A new method for approximating vector autoregressive processes by finite-state Markov chains," MPRA Paper 33827, University Library of Munich, Germany.
  6. Nikolay Gospodinov & Damba Lkhagvasuren, 2011. "A Moment-Matching Method for Approximating Vector Autoregressive Processes by Finite-State Markov Chains," Working Papers, Concordia University, Department of Economics 11005, Concordia University, Department of Economics, revised 16 Dec 2011.
  7. Damba Lkhagvasuren, 2006. "Education, Mobility and the College Wage Premium," Working Papers, Concordia University, Department of Economics 14001, Concordia University, Department of Economics, revised Nov 2013.
  8. Viktor Tsyrennikov & Serhiy Stepanchuk & Katrin Rabitsch, 2013. "International Portfolios: A Comparison of Solution Methods," 2013 Meeting Papers, Society for Economic Dynamics 1146, Society for Economic Dynamics.
  9. repec:fip:fedreq:y:2011:i:3q:p:255-326:n:vol.97no.3 is not listed on IDEAS
  10. Fatih Guvenen, 2011. "Macroeconomics with hetereogeneity : a practical guide," Economic Quarterly, Federal Reserve Bank of Richmond, Federal Reserve Bank of Richmond, issue 3Q, pages 255-326.

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