Tractable Latent State Filtering for Non-Linear DSGE Models Using a Second-Order Approximation and Pruning

This paper develops a novel approach for estimating latent state variables of Dynamic Stochastic General Equilibrium (DSGE) models that are solved using a second-order accurate approximation. I apply the Kalman filter to a state-space representation of the second-order solution based on the 'pruning' scheme of Kim et al. (J Econ Dyn Control 32:3397-3414, 2008). By contrast to particle filters, no stochastic simulations are needed for the deterministic filter here; the present method is thus much faster; in terms of estimation accuracy for latent states it is competitive with the standard particle filter. Use of the pruning scheme distinguishes the filter here from the deterministic Quadratic Kalman filter presented by Ivashchenko (Comput Econ, 43:71-82, 2014). The filter here performs well even in models with big shocks and high curvature.