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A note on the accuracy of Markov-chain approximations to highly persistent AR(1) processes

  • Flodén, Martin

This note examines the accuracy of methods that approximate AR(1) processes with discrete Markov chains. Tauchen and Hussey's [Tauchen, G., Hussey, R., 1991. Quadrature-based methods for obtaining approximate solutions to nonlinear asset pricing models. Econometrica 59, 371-396] method has problems under high autocorrelation. I suggest an alternative weighting function, and note that Tauchen's [Tauchen, G., 1986. Finite state Markov-chain approximations to univariate and vector autoregressions. Economics Letters 20, 177-181] method is relatively robust.

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File URL: http://www.sciencedirect.com/science/article/B6V84-4PV2RS5-1/1/1a2962b7efa8f9a673e4f8d3a01f80b5
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Article provided by Elsevier in its journal Economics Letters.

Volume (Year): 99 (2008)
Issue (Month): 3 (June)
Pages: 516-520

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Handle: RePEc:eee:ecolet:v:99:y:2008:i:3:p:516-520
Contact details of provider: Web page: http://www.elsevier.com/locate/ecolet

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  1. Glenn R. Hubbard & Jonathan Skinner & Stephen P. Zeldes, . "Precautionary Saving and Social Insurance," Rodney L. White Center for Financial Research Working Papers 03-95, Wharton School Rodney L. White Center for Financial Research.
  2. Tauchen, George, 1986. "Finite state markov-chain approximations to univariate and vector autoregressions," Economics Letters, Elsevier, vol. 20(2), pages 177-181.
  3. Storesletten, Kjetil & Telmer, Chris & Yaron, Amir, 2002. "Consumption and Risk Sharing Over the Life Cycle," Seminar Papers 702, Stockholm University, Institute for International Economic Studies.
  4. S. Rao Aiyagari, 1993. "Uninsured idiosyncratic risk and aggregate saving," Working Papers 502, Federal Reserve Bank of Minneapolis.
  5. Tauchen, George & Hussey, Robert, 1991. "Quadrature-Based Methods for Obtaining Approximate Solutions to Nonlinear Asset Pricing Models," Econometrica, Econometric Society, vol. 59(2), pages 371-96, March.
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