Solving the DMP Model Accurately
43 Pages Posted: 27 Jun 2013 Last revised: 8 Jan 2014
Date Written: December 2013
An accurate global algorithm is crucial for quantifying the dynamics of the Diamond-Mortensen-Pissarides model. Loglinearization understates the mean and volatility of unemployment, overstates the unemployment-vacancy correlation, and ignores impulse responses that are an order of magnitude larger in recessions than in booms. Although improving on loglinearization, the second-order perturbation in logs also induces large approximation errors. We demonstrate these insights within the context of Hagedorn and Manovskii (2008). Our quantitative results highlight the extreme importance of accurately accounting for nonlinear dynamics in quantitative macroeconomic studies.
Keywords: Search and matching frictions, the unemployment volatility puzzle, global approximation methods, projection, loglinearization, nonlinear impulse response functions
JEL Classification: E24, E32, J63, J64
Suggested Citation: Suggested Citation