Efficient VAR Discretization

26 Pages Posted: 23 Jul 2020

See all articles by Grey Gordon

Grey Gordon

Federal Reserve Banks - Federal Reserve Bank of Richmond

Date Written: June, 2020


The standard approach to discretizing VARs uses tensor grids. However, when the VAR components exhibit significant unconditional correlations or when there are more than a few variables, this approach creates large inefficiencies because some discretized states will be visited with only vanishingly small probability. I propose pruning these low-probability states, thereby constructing an efficient grid. I investigate how much an efficient grid improves accuracy in the context of an AR(2) model and a small-scale New Keynesian model featuring four shocks. In both contexts, the efficient grid vastly increases accuracy.

Keywords: VAR, Autoregressive, Discretization, New Keynesian

JEL Classification: C32, C63, E32, E52

Suggested Citation

Gordon, Grey, Efficient VAR Discretization (June, 2020). FRB Richmond Working Paper No. 20-06, Available at SSRN: https://ssrn.com/abstract=3658583 or http://dx.doi.org/10.21144/wp20-06

Grey Gordon (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

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