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Second-order approximation of dynamic models with time-varying risk

  • Benigno, Gianluca
  • Benigno, Pierpaolo
  • Nisticò, Salvatore

This paper provides first and second-order approximation methods for the solution of non-linear dynamic stochastic models in which the exogenous state variables follow conditionally linear stochastic processes displaying time-varying risk. The first-order approximation is consistent with a conditionally linear model in which risk is still time-varying but has no distinct role – separated from the primitive stochastic disturbances – in influencing the endogenous variables. The second-order approximation of the solution, instead, is sufficient to get this role. Moreover, risk premia, evaluated using only a first-order approximation of the solution, will be also time varying.

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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 37 (2013)
Issue (Month): 7 ()
Pages: 1231-1247

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Handle: RePEc:eee:dyncon:v:37:y:2013:i:7:p:1231-1247
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

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