How Non-Gaussian Shocks Affect Risk Premia in Non-Linear DSGE Models

48 Pages Posted: 18 Mar 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: March 15, 2011

Abstract

This paper studies how non-Gaussian shocks affect risk premia in DSGE models approximated to second and third order. Based on an extension of the work by Schmitt-Grohe and Uribe to third order, we derive propositions for how rare disasters, stochastic volatility, and GARCH affect any risk premia in a wide class of DSGE models. To quantify these effects, we then 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 mean level of the ten-year nominal term premium, whereas a key effect of stochastic volatility and GARCH is an increase in the variability of this premium.

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

JEL Classification: C68, E30, E43, E44, G12

Suggested Citation

Andreasen, Martin M., How Non-Gaussian Shocks Affect Risk Premia in Non-Linear DSGE Models (March 15, 2011). Bank of England Working Paper No. 417, Available at SSRN: https://ssrn.com/abstract=1786646 or http://dx.doi.org/10.2139/ssrn.1786646

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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