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Disaster risk and preference shifts in a New Keynesian model

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  • Isoré, Marlène
  • Szczerbowicz, Urszula

Abstract

This paper analyzes the effects of a change in a small but time-varying “disaster risk” à la Gourio (2012) in a New Keynesian model. In a real business cycle framework, the disaster risk has been successful in replicating observed moments of equity premia. However, responses of macroeconomic variables critically depend on the value of the elasticity of intertemporal substitution (EIS). In particular, we show here that an increase in the probability of disaster causes a recession only in case of an EIS larger than unity, which may be arbitrarily large. Nevertheless, we also find that incorporating sticky prices allows to conciliate recessionary effects of the disaster risk with a plausible value of the EIS. A higher disaster risk is then also associated with an increase in the discount factor and with deflation, making it consistent with the preference shock literature (Christiano et al., 2011).

Suggested Citation

  • Isoré, Marlène & Szczerbowicz, Urszula, 2015. "Disaster risk and preference shifts in a New Keynesian model," MPRA Paper 65643, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:65643
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    More about this item

    Keywords

    disaster risk; rare events; uncertainty; asset pricing; DSGE models; New Keynesian models; business cycles;
    All these keywords.

    JEL classification:

    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming

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