The dynamic properties of micro based stochastic macro models are often analyzed through a linearization around the associated deterministic steady state. Recent literature has investigated the error made by such a deterministic approximation. Complementary to this literature we investigate how the linearization affects the stochastic properties of the original model. We consider a simple real business cycle model with noisy learning by doing. The solution has a stationary distribution that exhibits moment failure and has an unbounded support. The linear approximation, however, yields a stationary distribution with possibly a bounded support and all moments finite.

Additional Metadata
Keywords ARCH process, Linearization, real business cycle model, stochastic difference equation
Publisher Tinbergen Institute
Persistent URL hdl.handle.net/1765/20748
Citation
Babus, A.M., & de Vries, C.G.. (2010). Global Stochastic Properties of Dynamic Models and their Linear Approximations (No. TI 2010-081/2). Discussion paper / Tinbergen Institute. Tinbergen Institute. Retrieved from http://hdl.handle.net/1765/20748