Computing Stochastic Dynamic Economic Models with a Large Number of State Variables: A Description and Application of a Smolyak-Collocation Method
Federal Reserve Bank of Minneapolis
University of Pennsylvania - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)
University of Zurich; Swiss Finance Institute
NBER Working Paper No. t0345
We describe a sparse grid collocation algorithm to compute recursive solutions of dynamic economies with a sizable number of state variables. We show how powerful this method may be in applications by computing the nonlinear recursive solution of an international real business cycle model with a substantial number of countries, complete insurance markets and frictions that impede frictionless international capital flows. In this economy the aggregate state vector includes the distribution of world capital across different countries as well as the exogenous country-specific technology shocks. We use the algorithm to efficiently solve models with 2, 4, and 6 countries (i.e., up to 12 continuous state variables).
Number of Pages in PDF File: 31
Date posted: October 15, 2007
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