Risk Matters: The Real Effects of Volatility Shocks

57 Pages Posted: 19 May 2009

See all articles by Jesús Fernández-Villaverde

Jesús Fernández-Villaverde

University of Pennsylvania - Department of Economics; National Bureau of Economic Research (NBER)

Pablo Guerrón-Quintana

Federal Reserve Banks - Federal Reserve Bank of Philadelphia

Juan Francisco Rubio-Ramirez

Federal Reserve Bank of Atlanta - Research Department

Martín Uribe

Columbia University - Graduate School of Arts and Sciences - Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: April 2009

Abstract

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.

Keywords: DSGE Models, Small Open Economy, Stochastic Volatility

JEL Classification: C32, C63, F32, F41

Suggested Citation

Fernández-Villaverde, Jesús and Guerron-Quintana, Pablo and Rubio-Ramirez, Juan Francisco and Uribe, Martin, Risk Matters: The Real Effects of Volatility Shocks (April 2009). CEPR Discussion Paper No. DP7264. Available at SSRN: https://ssrn.com/abstract=1405041

Jesús Fernández-Villaverde (Contact Author)

University of Pennsylvania - Department of Economics ( email )

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Pablo Guerron-Quintana

Federal Reserve Banks - Federal Reserve Bank of Philadelphia ( email )

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Juan Francisco Rubio-Ramirez

Federal Reserve Bank of Atlanta - Research Department ( email )

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HOME PAGE: http://www.econ.umn.edu/~rubio

Martin Uribe

Columbia University - Graduate School of Arts and Sciences - Department of Economics ( email )

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212-854-8059 (Fax)

National Bureau of Economic Research (NBER)

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