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Exact likelihood computation for nonlinear DSGE models with heteroskedastic innovations

Listed author(s):
  • Amisano, Gianni
  • Tristani, Oreste

Phenomena such as the Great Moderation have increased the attention of macro-economists towards models where shock processes are not (log-)normal. This paper studies a class of discrete-time rational expectations models where the variance of exogenous innovations is subject to stochastic regime shifts. We first show that, up to a second-order approximation using perturbation methods, regime switching in the variances has an impact only on the intercept coefficients of the decision rules. We then demonstrate how to derive the exact model likelihood for the second-order approximation of the solution when there are as many shocks as observable variables. We illustrate the applicability of the proposed solution and estimation methods in the case of a small DSGE model. JEL Classification: E0, C63

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Paper provided by European Central Bank in its series Working Paper Series with number 1341.

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Date of creation: May 2011
Handle: RePEc:ecb:ecbwps:20111341
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  18. Jeffrey C. Fuhrer, 1996. "Monetary Policy Shifts and Long-Term Interest Rates," The Quarterly Journal of Economics, Oxford University Press, vol. 111(4), pages 1183-1209.
  19. Roger E. A. Farmer & Daniel F. Waggoner & Tao Zha, 2008. "Generalizing the Taylor principle: comment," FRB Atlanta Working Paper 2008-19, Federal Reserve Bank of Atlanta.
  20. Kenneth L. Judd, 1998. "Numerical Methods in Economics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262100711, December.
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  25. Rotemberg, Julio J, 1982. "Sticky Prices in the United States," Journal of Political Economy, University of Chicago Press, vol. 90(6), pages 1187-1211, December.
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