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State Space Models with Endogenous Regime Switching

Yoosoon Chang (), Junior Maih () and Fei Tan ()
Additional contact information
Fei Tan: Department of Economics, Chaifetz School of Business, Saint Louis University and Center for Economic Behavior and Decision-Making, Zhejiang University of Finance and Economics

No 2018-011, CAEPR Working Papers from Center for Applied Economics and Policy Research, Department of Economics, Indiana University Bloomington

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 non-linear 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.

Keywords: state space model; regime switching; endogenous feedback; filtering; DSGE model (search for similar items in EconPapers)
JEL-codes: C13 C32 E52 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge, nep-ecm and nep-ets
Date: 2018-11
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Working Paper: State Space Models with Endogenous Regime Switching (2018) Downloads
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