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Risk Matters: The Real Effects of Volatility Shocks

Listed author(s):
  • Jesús Fernández-Villaverde
  • Pablo A. Guerrón-Quintana
  • Juan Rubio-Ramírez
  • Martín Uribe

This paper shows how changes in the volatility of the real interest rate at which small open emerging economies borrow have a quantitatively important effect on real variables like output, consumption, investment, and hours worked. To motivate our investigation, we document the strong evidence of time-varying volatility in the real interest rates faced by a sample of four emerging small open economies: Argentina, Ecuador, Venezuela, and Brazil. We postulate a stochastic volatility process for real interest rates using T-bill rates and country spreads and estimate it with the help of the Particle filter and Bayesian methods. Then, we feed the estimated stochastic volatility process for real interest rates in an otherwise standard small open economy business cycle model. We calibrate eight versions of our model to match basic aggregate observations, two versions for each of the four countries in our sample. We find that an increase in real interest rate volatility triggers a fall in output, consumption, investment, and hours worked, and a notable change in the current account of the economy.

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File URL: http://www.nber.org/papers/w14875.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14875.

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Date of creation: Apr 2009
Publication status: published as Jesus Fernandez-Villaverde & Pablo Guerron-Quintana & Juan F. Rubio-Ramirez & Martin Uribe, 2011. "Risk Matters: The Real Effects of Volatility Shocks," American Economic Review, American Economic Association, vol. 101(6), pages 2530-61, October.
Handle: RePEc:nbr:nberwo:14875
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  1. Risk Matters: The Real Effects of Volatility Shocks: Comment (AER 2014) in ReplicationWiki
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