Finite State Markov-Chain Approximations to Highly Persistent Processes

Karen A. Kopecky () and Richard M. H. Suen ()

No 200904, Working Papers from University of California at Riverside, Department of Economics

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.

Keywords: Numerical Methods; Finite State Approximations; Optimal Growth Model (search for similar items in EconPapers)
JEL-codes: C63 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ecm, nep-ets and nep-ore
Date: 2009-05, Revised 2009-05
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http://mpra.ub.uni-muenchen.de/15122/1/MPRA_paper_15122.pdf First version, 2009 (application/pdf)

Related works:
Working Paper: Finite State Markov-Chain Approximations to Highly Persistent Processes (2009)
Working Paper: Finite State Markov-Chain Approximations to Highly Persistent Processes (2009)
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Persistent link: http://EconPapers.repec.org/RePEc:ucr:wpaper:200904

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