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State Space Models with Endogenous Regime Switching

Author

Listed:
  • Yoosoon Chang
  • Junior Maih
  • Fei Tan
Abstract
This article studies the estimation of state space models whose parameters are switching endogenously between two regimes, depending on whether an autoregressive latent factor crosses some threshold level. Endogeneity stems from the sustained impacts of transition innovations on the latent factor, absent from which our model reduces to one with exogenous Markov switching. Due to the flexible form of state space representation, this class of models is vastly broad, including classical regression models and the popular dynamic stochastic general equilibrium (DSGE) models as special cases. We develop a computationally efficient filtering algorithm to estimate the nonlinear model. Calculations are greatly simplified by appropriate augmentation of the transition equation and exploiting the conditionally linear and Gaussian structure. The algorithm is shown to be accurate in approximating both the likelihood function and filtered state variables. We also apply the filter to estimate a small-scale DSGE model with threshold-type switching in monetary policy rule, and find apparent empirical evidence of endogeneity in the U.S. monetary policy shifts. Overall, our approach provides a greater scope for understanding the complex interaction between regime switching and measured economic behavior.

Suggested Citation

  • Yoosoon Chang & Junior Maih & Fei Tan, 2018. "State Space Models with Endogenous Regime Switching," Working Papers No 9/2018, Centre for Applied Macro- and Petroleum economics (CAMP), BI Norwegian Business School.
    • Handle: RePEc:bny:wpaper:0067
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    Cited by:

    1. Chotipong Charoensom, 2024. "An Estimation of Regime Switching Models with Nonlinear Endogenous Switching," PIER Discussion Papers 217, Puey Ungphakorn Institute for Economic Research.
    2. Chang, Yoosoon & Maih, Junior & Tan, Fei, 2021. "Origins of monetary policy shifts: A New approach to regime switching in DSGE models," Journal of Economic Dynamics and Control, Elsevier, vol. 133(C).
    3. Shayan Zakipour-Saber, 2019. "State-dependent Monetary Policy Regimes," Working Papers 882, Queen Mary University of London, School of Economics and Finance.
    4. Tolga Özden, 2021. "Heterogeneous Expectations and the Business Cycle at the Effective Lower Bound," Working Papers 714, DNB.
    5. Kirstin Hubrich & Daniel F. Waggoner, 2022. "The transmission of financial shocks and leverage of financial institutions: An endogenous regime switching framework," Finance and Economics Discussion Series 2022-034, Board of Governors of the Federal Reserve System (U.S.).
    6. Yong Song & Tomasz Wo'zniak, 2020. "Markov Switching," Papers 2002.03598, arXiv.org.
    7. Martin Harding & Rafael Wouters, 2022. "Risk and State-Dependent Financial Frictions," Staff Working Papers 22-37, Bank of Canada.

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    More about this item

    Keywords

    state space model; regime switching; endogenous feedback; filtering; DSGE model;
    All these keywords.

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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