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Exact likelihood computation for nonlinear DSGE models with heteroskedastic innovations

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  • Tristani, Oreste
  • Amisano, Gianni

Abstract

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

Suggested Citation

  • Tristani, Oreste & Amisano, Gianni, 2011. "Exact likelihood computation for nonlinear DSGE models with heteroskedastic innovations," Working Paper Series 1341, European Central Bank.
  • Handle: RePEc:ecb:ecbwps:20111341
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    References listed on IDEAS

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    Cited by:

    1. Tao Zha & Juan F. Rubio-Ramirez & Daniel F. Waggoner & Andrew T. Foerster, 2010. "Perturbation Methods for Markov-Switching Models," 2010 Meeting Papers 239, Society for Economic Dynamics.
    2. Negro, Marco Del & Schorfheide, Frank, 2013. "DSGE Model-Based Forecasting," Handbook of Economic Forecasting, Elsevier.
    3. Viktors Ajevskis, 2013. "Non-Local Solutions to Dynamic Equilibrium Models: the Approximate Stable Manifolds Approach," Working Papers 2013/03, Latvijas Banka.
    4. Hall, Jamie, 2012. "Consumption dynamics in general equilibrium," MPRA Paper 43933, University Library of Munich, Germany.
    5. Carlo Altavilla & Raffaella Giacomini & Riccardo Costantini, 2014. "Bond Returns and Market Expectations," Journal of Financial Econometrics, Society for Financial Econometrics, pages 708-729.
    6. Horváth, Roman & Maršál, Aleš, 2014. "The term structure of interest rates in a small open economy DSGE model with Markov switching," FinMaP-Working Papers 22, Collaborative EU Project FinMaP - Financial Distortions and Macroeconomic Performance: Expectations, Constraints and Interaction of Agents.

    More about this item

    Keywords

    DSGE models; regime switching; second-order approximation; time-varying volatility;

    JEL classification:

    • E0 - Macroeconomics and Monetary Economics - - General
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques

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