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- Title
IMPLEMENTING STOCHASTIC VOLATILITY IN DSGE MODELS: A COMMENT.
- Authors
Bretscher, Lorenzo; Hsu, Alex; Tamoni, Andrea
- Abstract
We highlight a state variable misspecification with one accepted method to implement stochastic volatility (SV) in DSGE models when transforming the nonlinear state-innovation dynamics to its linear representation. Although the technique is more efficient numerically, we show that it is not exact but only serves as an approximation when the magnitude of SV is small. Not accounting for this approximation error may induce substantial spurious volatility in macroeconomic series, which could lead to incorrect inference about the performance of the model. We also show that, by simply lagging and expanding the state vector, one can obtain the correct state-space specification. Finally, we validate our augmented implementation approach against an established alternative through numerical simulation.
- Subjects
APPROXIMATION error; COMPUTER simulation
- Publication
Macroeconomic Dynamics, 2020, Vol 24, Issue 4, p935
- ISSN
1365-1005
- Publication type
Article
- DOI
10.1017/S1365100518000548