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Why Does Risk Matter More in Recessions than in Expansions?

Author

Listed:
  • Martin M. Andreasen

    (Department of Economics and Business Economics, CREATES, Aarhus University, The Danish Finance Institute)

  • Giovanni Caggiano

    (Monash University, University of Padova)

  • Efrem Castelnuovo

    (University of Padova)

  • Giovanni Pellegrino

    (Department of Economics and Business Economics, Aarhus University)

Abstract

This paper uses a nonlinear vector autoregression and a non-recursive identification strategy to show that an equal-sized uncertainty shock generates a larger contraction in real activity when growth is low (as in recessions) than when growth is high (as in expansions). An estimated New Keynesian model with recursive preferences and approximated to third order around its risky steady state replicates these state-dependent responses. The key mechanism behind this result is that firms display a stronger upward nominal pricing bias in recessions than in expansions, because recessions imply higher inflation volatility and higher marginal utility of consumption than expansions.

Suggested Citation

  • Martin M. Andreasen & Giovanni Caggiano & Efrem Castelnuovo & Giovanni Pellegrino, 2021. "Why Does Risk Matter More in Recessions than in Expansions?," Economics Working Papers 2021-12, Department of Economics and Business Economics, Aarhus University.
  • Handle: RePEc:aah:aarhec:2021-12
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    References listed on IDEAS

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    Full references (including those not matched with items on IDEAS)

    Citations

    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Why does risk matter more in recessions than in expansions?
      by Christian Zimmermann in NEP-DGE blog on 2021-11-15 16:41:15

    Citations

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    Cited by:

    1. Ambrocio, Gene, 2020. "Inflationary household uncertainty shocks," Research Discussion Papers 5/2020, Bank of Finland.
    2. Efrem Castelnuovo, 2022. "Uncertainty Before and During COVID-19: A Survey," "Marco Fanno" Working Papers 0279, Dipartimento di Scienze Economiche "Marco Fanno".
    3. Giovanni Pellegrino & Federico Ravenna & Gabriel Züllig, 2021. "The Impact of Pessimistic Expectations on the Effects of COVID‐19‐Induced Uncertainty in the Euro Area," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 83(4), pages 841-869, August.

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    More about this item

    Keywords

    New Keynesian Model; Nonlinear SVAR; Non-recursive identification; State-dependent uncertainty shock; Risky steady state;
    All these keywords.

    JEL classification:

    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)

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