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Discretization of highly persistent correlated AR(1) shocks

Author

Listed:
  • Lkhagvasuren, Damba
  • Galindev, Ragchaasuren
Abstract
The finite state Markov-Chain approximation method developed by Tauchen (1986) and Tauchen and Hussey (1991) is widely used in economics, finance and econometrics in solving for functional equations where state variables follow an autoregressive process. For highly persistent processes, the method requires a large number of discrete values for the state variables to produce close approximations which leads to an undesirable reduction in computational speed, especially in a multidimensional case. This paper proposes an alternative method of discretizing vector autoregressions. This method can be treated as an extension of Rouwenhorst's (1995) method which, according to our experiments, outperforms the existing methods in the scalar case for highly persistent processes. The new method works well as an approximation that is much more robust to the number of discrete values for a wide range of the parameter space.

Suggested Citation

  • Lkhagvasuren, Damba & Galindev, Ragchaasuren, 2008. "Discretization of highly persistent correlated AR(1) shocks," MPRA Paper 22523, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:22523
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    References listed on IDEAS

    as
    1. Tauchen, George, 1986. "Finite state markov-chain approximations to univariate and vector autoregressions," Economics Letters, Elsevier, vol. 20(2), pages 177-181.
    2. Karen Kopecky & Richard Suen, 2010. "Finite State Markov-chain Approximations to Highly Persistent Processes," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 13(3), pages 701-714, July.
    3. Terry, Stephen J. & Knotek II, Edward S., 2011. "Markov-chain approximations of vector autoregressions: Application of general multivariate-normal integration techniques," Economics Letters, Elsevier, vol. 110(1), pages 4-6, January.
    4. Mortensen, Dale & Pissarides, Christopher, 2011. "Job Creation and Job Destruction in the Theory of Unemployment," Ekonomicheskaya Politika / Economic Policy, Russian Presidential Academy of National Economy and Public Administration, vol. 1, pages 1-19.
    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 371-396, March.
    6. Flodén, Martin, 2008. "A note on the accuracy of Markov-chain approximations to highly persistent AR(1) processes," Economics Letters, Elsevier, vol. 99(3), pages 516-520, June.
    7. Unknown, 1986. "Letters," Choices: The Magazine of Food, Farm, and Resource Issues, Agricultural and Applied Economics Association, vol. 1(4), pages 1-9.
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    More about this item

    Keywords

    Finite State Markov-Chain Approximation; Discretization of Multivariate Autoregressive Processes; Transition Matrix; Numerical Methods; Value Function Iteration; the Rouwenhorst method; VAR;
    All these keywords.

    JEL classification:

    • J60 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - General
    • C60 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - General

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