Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/56137
Authors: 
Year of Publication: 
2007
Series/Report no.: 
SSE/EFI Working Paper Series in Economics and Finance No. 656
Publisher: 
Stockholm School of Economics, The Economic Research Institute (EFI), Stockholm
Abstract: 
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 Tauchen-Hussey method, and I also note that the older method suggested by Tauchen (1986) is relatively robust to high autocorrelation.
Subjects: 
numerical methods
income processes
autoregressive process
JEL: 
C60
Document Type: 
Working Paper

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