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Finite State Markov-Chain Approximations to Highly Persistent Processes

Author Info

  • Karen A. Kopecky

    (Department of Economics, The University of Western Ontario)

  • Richard M. H. Suen

    ()

    (Department of Economics, University of California Riverside)

Abstract

This paper re-examines the Rouwenhorst method of approximating first-order autoregressive processes. This method is appealing because it can match the conditional and unconditional mean, the conditional and unconditional variance and the first-order autocorrelation of any AR(1) process. This paper provides the first formal proof of this and other results. When comparing to five other methods, the Rouwenhorst method has the best performance in approximating the business cycle moments generated by the stochastic growth model. It is shown that, equipped with the Rouwenhorst method, an alternative approach to generating these moments has a higher degree of accuracy than the simulation method.

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File URL: http://mpra.ub.uni-muenchen.de/15122/1/MPRA_paper_15122.pdf
File Function: First version, 2009
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Paper provided by University of California at Riverside, Department of Economics in its series Working Papers with number 200904.

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Length: 52 pages
Date of creation: May 2009
Date of revision: May 2009
Handle: RePEc:ucr:wpaper:200904
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Keywords: Numerical Methods; Finite State Approximations; Optimal Growth Model;

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Find related papers by JEL classification:
  • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques

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  1. Tauchen, George, 1990. "Solving the Stochastic Growth Model by Using Quadrature Methods and Value-Function Iterations," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(1), pages 49-51, January.
  2. 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.
  3. Robert G. King & Sergio T. Rebelo, 2000. "Resuscitating Real Business Cycles," RCER Working Papers 467, University of Rochester - Center for Economic Research (RCER).
  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. John B. Taylor & Harald Uhlig, 1989. "Solving Nonlinear Stochastic Growth Models: A Comparison of Alternative Solution Methods," NBER Working Papers 3117, National Bureau of Economic Research, Inc.
  6. Aruoba, S. Boragan & Fernandez-Villaverde, Jesus & Rubio-Ramirez, Juan F., 2006. "Comparing solution methods for dynamic equilibrium economies," Journal of Economic Dynamics and Control, Elsevier, vol. 30(12), pages 2477-2508, December.
  7. Craig Burnside, 1998. "Discrete State-Space Methods for the Study of Dynamic Economies," QM&RBC Codes 125, Quantitative Macroeconomics & Real Business Cycles.
  8. Jerome Adda & Russell W. Cooper, 2003. "Dynamic Economics: Quantitative Methods and Applications," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262012014, December.
  9. Tauchen, George, 1986. "Finite state markov-chain approximations to univariate and vector autoregressions," Economics Letters, Elsevier, vol. 20(2), pages 177-181.
  10. Lkhagvasuren, Damba & Galindev, Ragchaasuren, 2008. "Discretization of highly persistent correlated AR(1) shocks," MPRA Paper 22523, University Library of Munich, Germany.
  11. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
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Blog mentions

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  1. MC Approximations for ARs
    by Agent Continuum in Agent Continuum on 2010-06-20 02:17:57
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