A note on the accuracy of Markov-chain approximations to highly persistent AR ( 1 )-processes

@inproceedings{Flodn2007ANO,
  title={A note on the accuracy of Markov-chain approximations to highly persistent AR ( 1 )-processes},
  author={Martin Flod{\'e}n},
  year={2007}
}
  • Martin Flodén
  • Published 2007
This note examines the accuracy of methods that are commonly used to approximate AR(1)-processes with discrete Markov chains. The quadrature-based method suggested by Tauchen and Hussey (1991) generates excellent approximations with a small number of nodes when the autocorrelation is low or modest. This method however has problems when the autocorrelation is high, as it typically is found to be in recent empirical studies of income processes. I suggest an alternative weighting function for the… CONTINUE READING

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