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Risk news shocks and the business cycle

Listed author(s):
  • Pinter, Gabor

    ()

    (Bank of England)

  • Theodoridis, Konstantinos

    ()

    (Bank of England)

  • Yates, Tony

    ()

    (University of Bristol and Centre for Macroeconomics)

We identify a ‘risk news' shock in a vector autoregression (VAR), modifying Barsky and Sims’s procedure, while incorporating sign restrictions to simultaneously identify monetary policy, technology and demand shocks. The VAR-identifed risk news shock is estimated to account for around 2%-12% of business cycle fluctuations depending on which risk proxy we use; regardless, contemporaneous risk and risk news shocks together account for about 20%. This is substantially lower than the 60% reported in Christiano, Motto, and Rostagno’s full-information exercise. We fit a DSGE model with financial frictions to these impulse responses and find that, in order to match the fall in consumption recorded by the VAR, we have to allow for 75% of consumers to be living hand-to-mouth.

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Paper provided by Bank of England in its series Bank of England working papers with number 483.

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Length: 47 pages
Date of creation: 20 Dec 2013
Handle: RePEc:boe:boeewp:0483
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