Exact Likelihood Computation for Nonlinear DSGE Models with Heteroskedastic Innovations
43 Pages Posted: 31 May 2011
Date Written: May 13, 2011
Abstract
Phenomena such as the Great Moderation have increased the attention of macro-economists towards models where shock processes are not (log-) normal. This paper studies a class of discrete-time rational expectations models where the variance of exogenous innovations is subject to stochastic regime shifts. We first show that, up to a second-order approximation using perturbation methods, regime switching in the variances has an impact only on the intercept coefficients of the decision rules. We then demonstrate how to derive the exact model likelihood for the second-order approximation of the solution when there are as many shocks as observable variables. We illustrate the applicability of the proposed solution and estimation methods in the case of a small DSGE model.
Keywords: DSGE models, second-order approximation, regime switching, time-varying volatility
JEL Classification: E0, C63
Suggested Citation: Suggested Citation
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