Asset Prices, Business Cycles, and Markov-Perfect Fiscal Policy when Agents are Risk-Sensitive
AbstractWe study a business cycle model in which a benevolent scal authority must determine the optimal provision of government services, while lacking credibility, lump-sum taxes, and the ability to bond fi nance de ficits. Households and the fi scal authority have risk sensitive pref- erences. We find that outcomes are affected importantly by the households risk sensitivity, but not by the fi scal authoritys. Further, while household risk-sensitivity induces a strong precautionary saving motive, which raises capital and lowers the return on assets, its effects on fluctuations and the business cycle are generally small, although more pronounced for negative shocks. Holding the stochastic steady state constant, increases in household risk-sensitivity lower the risk-free rate and raise the return on equity, increasing the equity premium. Finally, although risk-sensitivity has little effect on the provision of government services, it does cause the fi scal authority to lower the income tax rate. An additional contribution of this paper is to present a method for computing Markov-perfect equilibria in models where private agents and the government are risk-sensitive decisionmakers.
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Bibliographic InfoPaper provided by Business School - Economics, University of Glasgow in its series Working Papers with number 2013_15.
Date of creation: Sep 2013
Date of revision:
Asset prices; business cycles; risk-sensitivity; Markov-Perfect fiscal policy.;
Other versions of this item:
- Richard Dennis, 2013. "Asset Prices, Business Cycles, and Markov-Perfect Fiscal Policy when Agents are Risk-Sensitive," CAMA Working Papers 2013-69, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
- Dennis, Richard, 2013. "Asset Prices, Business Cycles, and Markov-Perfect Fiscal Policy when Agents are Risk-Sensitive," SIRE Discussion Papers 2013-79, Scottish Institute for Research in Economics (SIRE).
- E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
- C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
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