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Switching Volatility in a Nonlinear Open Economy

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  • Jonathan Benchimol

    () (Bank of Israel)

  • Sergey Ivashchenko

    (Russian Academy of Sciences (IREP), Financial Research Institute, and Saint-Petersburg State University, Saint Petersburg, Russia)

Abstract

Uncertainty about a regime's economy can change drastically around a crisis. An imported crisis such as the global financial crisis in the euro area highlights the effect of foreign shocks. Estimating an open-economy nonlinear dynamic stochastic general equilibrium model for the euro area and the United States including Markov-switching volatility shocks, we show that these shocks were significant during the global financial crisis compared with periods of calm. We describe how US shocks from both the real economy and financial markets affected the euro area economy and how bond reallocation occurred between short- and long-term maturities during the global financial crisis. Importantly, the estimated nonlinearities when domestic and foreign financial markets influence the economy, should not be neglected. The nonlinear behavior of market-related variables highlights the importance of higher-order estimation for providing additional interpretations to policymakers.􀀠

Suggested Citation

  • Jonathan Benchimol & Sergey Ivashchenko, 2020. "Switching Volatility in a Nonlinear Open Economy," Bank of Israel Working Papers 2020.04, Bank of Israel.
  • Handle: RePEc:boi:wpaper:2020.04
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    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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