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A note on the accuracy of Markov-chain approximations to highly persistent AR(1) processes

Authors
Journal
Economics Letters
0165-1765
Publisher
Elsevier
Publication Date
Volume
99
Issue
3
Identifiers
DOI: 10.1016/j.econlet.2007.09.040
Keywords
  • Numerical Methods
  • Income Processes
  • Autoregressive Process

Abstract

Abstract This note examines the accuracy of methods that approximate AR(1) processes with discrete Markov chains. Tauchen and Hussey's [Tauchen, G., Hussey, R., 1991. Quadrature-based methods for obtaining approximate solutions to nonlinear asset pricing models. Econometrica 59, 371–396] method has problems under high autocorrelation. I suggest an alternative weighting function, and note that Tauchen's [Tauchen, G., 1986. Finite state Markov-chain approximations to univariate and vector autoregressions. Economics Letters 20, 177–181] method is relatively robust.

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