Interdisciplinary Center (IDC) Herzliya
P.O.Box 167. Herzliya, 4610101
Information about this author at RePEc
NBER Working Papers and Publications
|February 2016||Solution Methods for Models with Rare Disasters|
with Jesús Fernández-Villaverde: w21997
This paper compares different solution methods for computing the equilibrium of dynamic stochastic general equilibrium (DSGE) models with rare disasters along the line of those proposed by Rietz (1988), Barro (2006}, Gabaix (2012), and Gourio (2012). DSGE models with rare disasters require solution methods that can handle the large non-linearities triggered by low-probability, high-impact events with sufficient accuracy and speed. We solve a standard New Keynesian model with Epstein-Zin preferences and time-varying disaster risk with perturbation, Taylor projection, and Smolyak collocation. Our main finding is that Taylor projection delivers the best accuracy/speed tradeoff among the tested solutions. We also document that even third-order perturbations may generate solutions that suffer f...