Discretization of stochastic differential equations and econometric forecasting: An application to time‐varying autoregressions

Abstract

AbstractContinuous time versions of time varying Vector Autoregressions are stochastic differential equations. Optimal discretization of Stochastic Differential Equations cannot be obtained by replacing all differentials by the corresponding first differences. In this paper we obtain the optimal discretization for time varying VARS. The results are applied to predicting the consumer price index.