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Discretization of highly persistent correlated AR(1) shocks

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  • Lkhagvasuren, Damba
  • Galindev, Ragchaasuren

Abstract

The finite state Markov-Chain approximation method developed by Tauchen (1986) and Tauchen and Hussey (1991) is widely used in economics, finance and econometrics in solving for functional equations where state variables follow an autoregressive process. For highly persistent processes, the method requires 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 multidimensional case. This paper proposes an alternative method of discretizing vector autoregressions. This method can be treated as an extension of Rouwenhorst's (1995) method which, according to our experiments, 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

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 22523.

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Date of creation: 23 Nov 2008
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Handle: RePEc:pra:mprapa:22523

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Keywords: Finite State Markov-Chain Approximation; Discretization of Multivariate Autoregressive Processes; Transition Matrix; Numerical Methods; Value Function Iteration; the Rouwenhorst method; VAR;

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  1. Flodén, Martin, 2008. "A note on the accuracy of Markov-chain approximations to highly persistent AR(1) processes," Economics Letters, Elsevier, Elsevier, vol. 99(3), pages 516-520, June.
  2. Tauchen, George, 1986. "Finite state markov-chain approximations to univariate and vector autoregressions," Economics Letters, Elsevier, Elsevier, vol. 20(2), pages 177-181.
  3. 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.
  4. 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.
  5. 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.
  6. Lu Zhang, 2005. "The Value Premium," Journal of Finance, American Finance Association, American Finance Association, vol. 60(1), pages 67-103, 02.
  7. 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.
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Citations

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Cited by:
  1. Gospodinov, Nikolay & Lkhagvasuren, Damba, 2013. "A moment-matching method for approximating vector autoregressive processes by finite-state Markov chains," Working Paper, Federal Reserve Bank of Atlanta 2013-05, Federal Reserve Bank of Atlanta.
  2. 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.
  3. Zhao, Yan, 2011. "Borrowing constraints and the trade balance-output comovement," MPRA Paper 36902, University Library of Munich, Germany.
  4. Fatih Guvenen, 2011. "Macroeconomics With Heterogeneity: A Practical Guide," NBER Working Papers 17622, National Bureau of Economic Research, Inc.
  5. 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.
  6. Northwestern University & Damba Lkhagvasuren, 2007. "Big Locational Differences in Unemployment Despite High Labor Mobility," 2007 Meeting Papers, Society for Economic Dynamics 922, Society for Economic Dynamics.
  7. repec:fip:fedreq:y:2011:i:3q:p:255-326:n:vol.97no.3 is not listed on IDEAS
  8. Paul Gomme & Damba Lkhagvasuren, 2011. "The Cyclicality of Search Intensity in a Competitive Search Model," Working Papers, Concordia University, Department of Economics 11003, Concordia University, Department of Economics.
  9. 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.
  10. 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.

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