Solution Methods for Models with Rare Disasters

38 Pages Posted: 15 Feb 2016

See all articles by Jesús Fernández-Villaverde

Jesús Fernández-Villaverde

University of Pennsylvania - Department of Economics; National Bureau of Economic Research (NBER)

Oren Levintal

Interdisciplinary Center (IDC) Herzliyah

Multiple version iconThere are 2 versions of this paper

Date Written: February 2016

Abstract

This paper compares different solution methods for computing the equilibrium of dynamic stochastic general equilibrium (DSGE) models with rare disasters along the line of those proposed by Rietz (1988), Barro (2006}, Gabaix (2012), and Gourio (2012). DSGE models with rare disasters require solution methods that can handle the large non-linearities triggered by low-probability, high-impact events with sufficient accuracy and speed. We solve a standard New Keynesian model with Epstein-Zin preferences and time-varying disaster risk with perturbation, Taylor projection, and Smolyak collocation. Our main finding is that Taylor projection delivers the best accuracy/speed tradeoff among the tested solutions. We also document that even third-order perturbations may generate solutions that suffer from accuracy problems and that Smolyak collocation can be costly in terms of run time and memory requirements.

Suggested Citation

Fernández-Villaverde, Jesús and Levintal, Oren, Solution Methods for Models with Rare Disasters (February 2016). NBER Working Paper No. w21997. Available at SSRN: https://ssrn.com/abstract=2732474

Jesús Fernández-Villaverde (Contact Author)

University of Pennsylvania - Department of Economics ( email )

3718 Locust Walk
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Philadelphia, PA 19104
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National Bureau of Economic Research (NBER)

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United States

Oren Levintal

Interdisciplinary Center (IDC) Herzliyah ( email )

P.O. Box 167
Herzliya, 46150
Israel

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