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Department ofEconomics

Papers

Lower Bounds on Approximation Errors to Numerical Solutions of Dynamic Economic Models

Kenneth L. Judd, Lilia Maliar and Serguei Maliar

Working Paper, March 2017

Abstract


We propose a novel methodology for evaluating the accuracy of numerical solutions to dynamic economic models. It consists in constructing a lower bound on the size of approximation errors. A small lower bound on errors is a necessary condition for accuracy: If a lower error bound is unacceptably large, then the actual approximation errors are even larger, and hence, the approximation is inaccurate. Our lower-bound error analysis is complementary to the conventional upper-error (worst-case) bound analysis, which provides a sufficient condition for accuracy. As an illustration of our methodology, we assess approximation in the first- and second-order perturbation solutions for two stylized models: a neoclassical growth model and a new Keynesian model. The errors are small for the former model but unacceptably large for the latter model under some empirically relevant parameterizations.

 

LSB Research, ECON, Serguei Maliar, Working Papers