Estimating Macroeconomic Models of Financial Crises: An Endogenous Regime Switching Approach

40 Pages Posted: 28 Oct 2019

See all articles by Gianluca Benigno

Gianluca Benigno

London School of Economics & Political Science (LSE) - Department of Economics

Andrew T. Foerster

Federal Reserve Banks - Federal Reserve Bank of San Francisco

Chris Otrok

University of Missouri; Federal Reserve Banks - Federal Reserve Bank of St. Louis

Alessandro Rebucci

Johns Hopkins University - Carey Business School; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Date Written: June 20, 2019

Abstract

We develop a new approach to specifying, solving, and estimating DSGE models with occasionally binding collateral constraints. The new specification of the collateral constraint that we propose assumes that the transition from the unconstrained to the constrained state is a stochastic function of the endogenous level of leverage. This specification results in an endogenous regime-switching model, which we solve with a new general perturbation method, highlighting the importance of using a second-order approximation. Next, using Bayesian full information methods, we estimate a well-known model with an occasionally binding constraint, with Mexican quarterly data since 1981, considering a comprehensive set of shocks. We find that the estimated model fits the data well, characterizing both their second moments and the 1995 Tequila crisis period, without imposing a negative correlation between the productivity and the interest rate process. It yields estimates of the regime probabilities that align well with the narrative of Mexico's financial crisis and business cycle history. We also find that the estimated parameters of the financial friction are tighter than previously assumed in the literature; a cocktail of shocks that co-move in a particularly averse manner, rather than a sequence of unusually large negative shocks, precede large sudden stops episodes like the Tequila crisis; expenditure and impatience shocks drove Mexico's economy into the Tequila crisis, while productivity and interest shocks prevailed during that particular episode.

Keywords: Financial Crises, Endogenous Regime Switching, Bayesian Estimation, Occasionally Binding Constraints

JEL Classification: G01, E3, F41, C11

Suggested Citation

Benigno, Gianluca and Foerster, Andrew T. and Otrok, Christopher and Rebucci, Alessandro, Estimating Macroeconomic Models of Financial Crises: An Endogenous Regime Switching Approach (June 20, 2019). Available at SSRN: https://ssrn.com/abstract=3472296 or http://dx.doi.org/10.2139/ssrn.3472296

Gianluca Benigno

London School of Economics & Political Science (LSE) - Department of Economics ( email )

Houghton Street
London WC2A 2AE
United Kingdom
+44 20 7955 7807 (Phone)

Andrew T. Foerster

Federal Reserve Banks - Federal Reserve Bank of San Francisco ( email )

101 Market Street
San Francisco, CA 94105
United States

Christopher Otrok

University of Missouri ( email )

118 Professional Building
Columbia, MO 65211
United States

Federal Reserve Banks - Federal Reserve Bank of St. Louis ( email )

411 Locust St
Saint Louis, MO 63011
United States

Alessandro Rebucci (Contact Author)

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

HOME PAGE: http://carey.jhu.edu/faculty-research/faculty-directory/alessandro-rebucci-phd

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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