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How Non-Gaussian Shocks Affect Risk Premia in Non-Linear DSGE Models

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  • Martin M. Andreasen

    ()
    (Bank of England and CREATES)

Abstract

This paper studies how non-Gaussian shocks affect risk premia in DSGE models approximated to second and third order. Based on an extension of the results in Schmitt-Grohé & Uribe (2004) to third order, we derive propositions for how rare disasters, stochastic volatility, and GARCH affect any risk premia in a wide class of DSGE models. To quantify these effects, we then set up a standard New Keynesian DSGE model where total factor productivity includes rare disasters, stochastic volatility, and GARCH. We ?find that rare disasters increase the mean level of the 10-year nominal term premium, whereas a key effect of stochastic volatility and GARCH is an increase in the variability of this premium.

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Bibliographic Info

Paper provided by School of Economics and Management, University of Aarhus in its series CREATES Research Papers with number 2010-63.

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Length: 37
Date of creation: 10 Sep 2010
Date of revision:
Handle: RePEc:aah:create:2010-63

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Web page: http://www.econ.au.dk/afn/

Related research

Keywords: Epstain-Zin-Weil preferences; GARCH; rare disasters; risk premia; stochastic volatility.;

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References

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  1. Bianca De Paoli & Alasdair Scott & Olaf Weeken, 2006. "Asset pricing implications of a New Keynesian model," Computing in Economics and Finance 2006 358, Society for Computational Economics.
  2. Antonio Moreno & Geert Bekaert & Seonghoon Cho, 2004. "New-Keynesian Macroeconomics and the Term Structure," 2004 Meeting Papers 388, Society for Economic Dynamics.
  3. Eric Swanson & Gary Anderson & Andrew Levin, 2006. "Higher-order perturbation solutions to dynamic, discrete-time rational expectations models," Working Paper Series 2006-01, Federal Reserve Bank of San Francisco.
  4. Peter Hördahl & Oreste Tristani & David Vestin, 2008. "The Yield Curve and Macroeconomic Dynamics," Economic Journal, Royal Economic Society, vol. 118(533), pages 1937-1970, November.
  5. OndŘej KamenÍk, 2005. "Solving SDGE Models: A New Algorithm for the Sylvester Equation," Computational Economics, Society for Computational Economics, vol. 25(1), pages 167-187, February.
  6. Lawrence J. Christiano & Michele Boldrin & Jonas D. M. Fisher, 2001. "Habit Persistence, Asset Returns, and the Business Cycle," American Economic Review, American Economic Association, vol. 91(1), pages 149-166, March.
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Cited by:
  1. Benigno, Gianluca & Benigno, Pierpaolo & Nisticò, Salvatore, 2011. "Second Order Approximation of Dynamic Models with Time-Varying Risk," CEPR Discussion Papers 8177, C.E.P.R. Discussion Papers.
  2. Hakon Tretvoll, 2012. "Real exchange rate variability in a two country business cycle model," 2012 Meeting Papers 911, Society for Economic Dynamics.
  3. Hatcher, Michael, 2011. "Time-varying volatility, precautionary saving and monetary policy," Bank of England working papers 440, Bank of England.
  4. Andreasen, Martin, 2011. "An estimated DSGE model: explaining variation in term premia," Bank of England working papers 441, Bank of England.

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