On the Effects of Rare Disasters and Uncertainty Shocks for Risk Premia in Non-Linear DSGE Models

40 Pages Posted: 11 Sep 2010 Last revised: 14 Sep 2011

See all articles by Martin M. Andreasen

Martin M. Andreasen

Aarhus University; CREATES, Aarhus University

Multiple version iconThere are 2 versions of this paper

Date Written: September 14, 2011

Abstract

This paper studies how rare disasters and uncertainty shocks affect risk premia in DSGE models approximated to second and third order. Based on an extension of the results in Schmitt-Grohé & Uribe (2004) to third order, we derive propositions for how rare disasters, stochastic volatility, and GARCH affect any type of risk premia in a wide class of DSGE models. To quantify the effects, we set up a standard New Keynesian DSGE model where total factor productivity includes rare disasters, stochastic volatility, and GARCH. We find that rare disasters increase the level of the 10-year nominal term premium, whereas a key effect of uncertainty shocks, i.e. stochastic volatility and GARCH, is an increase in the variability of this premium.

Keywords: Epstain-Zin-Weil preferences, GARCH, rare disasters, risk premia, stochastic volatility

JEL Classification: C68, E3, E43, E44

Suggested Citation

Andreasen, Martin M., On the Effects of Rare Disasters and Uncertainty Shocks for Risk Premia in Non-Linear DSGE Models (September 14, 2011). Available at SSRN: https://ssrn.com/abstract=1674841 or http://dx.doi.org/10.2139/ssrn.1674841

Martin M. Andreasen (Contact Author)

Aarhus University ( email )

Aarhus
Denmark

CREATES, Aarhus University ( email )

School of Economics and Management
Building 1322, Bartholins Alle 10
DK-8000 Aarhus C
Denmark

HOME PAGE: http://econ.au.dk/research/research-centres/creates/people/junior-fellows/martin-andreasen/

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