IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Log in (now much improved!) to save this paper

What order? Perturbation methods for stochastic volatility asset pricing and business cycle models

Listed author(s):
  • Oliver de Groot

    ()

    (School of Economics and Finance, University of St Andrews)

When a DSGE model features stochastic volatility, is a third-order perturbation approximation sufficient? The answer is often no. A key parameter - the standard deviation of stochastic volatility innovations - does not appear in the coefficients of the decision rules of endogenous variables until a fourth- or sixth-order perturbation approximation (depending on the functional form of the stochastic volatility process). This paper shows analytically this general result and demonstrates, using three models, that important model moments can be imprecisely measured when the order of approximation is too low. i) In the Bansal-Yaron long-run risk model, the equity risk premium rises from 4.5% to 10% by going to sixth-order. ii) In a workhorse real business cycle model, the welfare cost of business cycles also rise when a fourth-order approximation properly accounts for the presence of stochastic volatility. iii) In a canonical New-Keynesian model, the risk-aversion parameter can be lowered while matching the term premium when a fourth-order approximation is used.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.st-andrews.ac.uk/~wwwecon/repecfiles/4/1611.pdf
Download Restriction: no

Paper provided by Department of Economics, University of St. Andrews in its series Discussion Paper Series, Department of Economics with number 201611.

as
in new window

Length:
Date of creation: 07 Sep 2016
Handle: RePEc:san:wpecon:1611
Contact details of provider: Postal:
School of Economics and Finance, University of St. Andrews, Fife KY16 9AL

Phone: 01334 462436
Fax: 01334 462444
Web page: https://www.st-andrews.ac.uk/economics/

More information through EDIRC

Order Information: Email:


No references listed on IDEAS
You can help add them by filling out this form.

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:san:wpecon:1611. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (the School of Economics)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.