Estimating Macroeconomic Models of Financial Crises: An Endogenous Regime-Switching Approach

Benigno, Gianluca; Foerster, Andrew T.; Otrok, Christopher; Rebucci, Alessandro

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Estimating Macroeconomic Models of Financial Crises: An Endogenous Regime-Switching Approach

Abstract: We estimate a workhorse dynamic stochastic general equilibrium (DSGE) model with an occasionally binding borrowing constraint. First, we propose a new speciﬁcation of the occasionally binding constraint, where the transition between the unconstrained and constrained states is a stochastic function of the leverage level and the constraint multiplier. This speciﬁcation maps into an endogenous regime-switching model. Second, we develop a general perturbation method for the solution of such a model. Third, we estimate the model with Bayesian methods to ﬁt Mexico’s business cycle and ﬁnancial crisis history since 1981. The estimated model ﬁts the data well, identifying three crisis episodes of varying duration and intensity: the Debt Crisis in the early 1980s, the Peso Crisis in the mid-1990s, and the Global Financial Crisis in the late 2000s. These crisis episodes display sluggish and long-lasting build-up and recovery phases driven by plausible combinations of shocks.

Keywords: financial crises; business cycles; endogenous regime-switching; Bayesian estimation; occasionally binding constraints; Mexico;

JEL Classification: G01; E3; F41; C11;