Implementing stochastic volatility in DSGE models: a comment

Bretscher, L, Hsu, A and Tamoni, A (2018) Implementing stochastic volatility in DSGE models: a comment. Macroeconomic Dynamics, 24 (4). pp. 935-950. ISSN 1365-1005

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.

More Details

Item Type: Article
Subject Areas: Finance
Date Deposited: 04 Jun 2020 09:17
Date of first compliant deposit: 04 Jun 2020
Last Modified: 08 Feb 2023 01:39
URI: https://lbsresearch.london.edu/id/eprint/1414
More

Export and Share


Download

Accepted Version - Text
  • Restricted to Repository staff only

Statistics

Altmetrics
View details on Dimensions' website

Downloads from LBS Research Online

View details

Actions (login required)

Edit Item Edit Item