On the Applicability of Global Approximation Methods for Models with Jump Discontinuities in Policy Functions

Arbeitspapier

We show that the standard Value Function Iteration (VFI) algorithm has difficulties approximating models with jump discontinuities in policy functions. We find that VFI fails to accurately identify the location and size of jump discontinuities while other methods - such as the Endogenous Grid Method (EGM) and a Finite Element Method (FEM) - are much better at approximating this class of models. We illustrate differences across methods using a standard plant-level investment model with both variable and fixed capital adjustment costs. We find that the policy functions generated by VFI are quite different from those generated by EGM and FEM. Importantly, these differences are economically significant: for our baseline parameterization VFI generates investment spikes that are 5-8% larger in comparison to the other two methods. The choice between EGM and FEM depends on the context. While EGM is faster than FEM, it is much more difficult to implement. For larger models, the modifications necessary to apply EGM can lead to high code complexity. On the other hand, FEM can accommodate larger models with minimal implementation differences and its high scalability can reduce computation time significantly.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: CESifo Working Paper ; No. 4837

Classification and Topics

• Classification: Wirtschaft ; Computational Techniques; Simulation Modeling ; Computable General Equilibrium Models ; Prices, Business Fluctuations, and Cycles: Forecasting and Simulation: Models and Applications
• Subject: dynamic equilibrium economies ; non-convex capital adjustment costs ; computational methods ; nonlinear solution methods

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Görtz, Christoph ; Mirza, Afrasiab
• Event: Veröffentlichung
• (who): Center for Economic Studies and ifo Institute (CESifo)
• (where): Munich
• (when): 2014

Further information

• Handle: http://hdl.handle.net/10419/102199
• Last update: 10.03.2025, 11:44 AM CET