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

Martin Floden ()

Economics Letters, 2008, vol. 99, issue 3, pages 516-520

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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Related works:
Working Paper: A Note on the Accuracy of Markov-Chain Approximations to Highly Persistent AR(1)-Processes (2007)
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