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State Space Models with Endogenous Regime Switching

Author

Listed:
  • Yoosoon Chang

    (Indiana University)

  • Fei Tan

    (Richard A. Chaifetz School of Business, Saint Louis University)

  • Xin Wei

    (Indiana University)

Abstract
This article studies the estimation of state space models whose parameters are switching endogenously between two regimes, depending on whether an autoregressive latent factor crosses some threshold level. Endogeneity stems from the sustained impacts of transition innovations on the latent factor, absent from which our model reduces to one with exogenous regime switching. Due to the flexible form of state space representation, this class of models is broad, including classical regression models and the popular dynamic stochastic general equilibrium (DSGE) models as special cases. We develop a computationally efficient filtering algorithm to estimate the nonlinear model. The algorithm is shown to be accurate in approximating both the likelihood function and filtered state variables. We also apply the filter to estimate a small-scale DSGE model with threshold-type switching in monetary policy rule, and that the Bayes factor decisively favors the endogenous switching version of the DSGE model over the fixed regime case. Overall, our approach provides a greater scope for understanding the complex interaction between regime switching and measured economic behavior.

Suggested Citation

  • Yoosoon Chang & Fei Tan & Xin Wei, 2018. "State Space Models with Endogenous Regime Switching," CAEPR Working Papers 2018-012, Center for Applied Economics and Policy Research, Department of Economics, Indiana University Bloomington.
    • Handle: RePEc:inu:caeprp:2018012
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    File URL: https://caepr.indiana.edu/RePEc/inu/caeprp/caepr2018-012.pdf
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    References listed on IDEAS

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    Cited by:

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    3. Kirstin Hubrich & Daniel F. Waggoner, 2022. "The Transmission of Financial Shocks and Leverage of Financial Institutions: An Endogenous Regime-Switching Framework," FRB Atlanta Working Paper 2022-5, Federal Reserve Bank of Atlanta.
    4. Tolga Özden, 2021. "Heterogeneous Expectations and the Business Cycle at the Effective Lower Bound," Working Papers 714, DNB.
    5. Martin Harding & Rafael Wouters, 2022. "Risk and State-Dependent Financial Frictions," Staff Working Papers 22-37, Bank of Canada.

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    More about this item

    Keywords

    state space model; regime switching; endogeneity; filtering; DSGE model;
    All these keywords.

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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