Working Paper

Efficient VAR Discretization

Abstract: The standard approach to discretizing VARs uses tensor grids. However, when the VAR components exhibit significant unconditional correlations or when there are more than a few variables, this approach creates large inefficiencies because some discretized states will be visited with only vanishingly small probability. I propose pruning these low-probability states, thereby constructing an efficient grid. I investigate how much an efficient grid improves accuracy in the context of an AR(2) model and a small-scale New Keynesian model featuring four shocks. In both contexts, the efficient grid vastly increases accuracy.

Keywords: VAR; Autoregressive; Discretization; New Keynesian;

JEL Classification: C32; C63; E32; E52;

https://doi.org/10.21144/wp20-06

Bibliographic Information

Provider: Federal Reserve Bank of Richmond

Part of Series: Working Paper

Publication Date: 2020-06-05

Number: 20-06