53 Pages Posted: 22 Mar 2017 Last revised: 20 Sep 2017
Date Written: September 8, 2017
Degree of risk aversion (RA) determines the impact of second moment shocks in DSGE models featuring stochastic volatility. Ceteris paribus, higher risk aversion leads to stronger responses of macroeconomic variables to volatility shocks, in contrast to the Tallarini (2000) irrelevance result, which still holds with respect to level shocks. The output, consumption, and investment responses roughly double in our model following volatility shocks of the same magnitude as RA increases from 5 to 15, making volatility shocks as economically significant as level shocks in the model. Our result adds another dimension of complication in extending macro-finance models that employ stochastic volatility, such as Bansal and Yaron (2004), from endowment economies to full general equilibrium as macroeconomic and asset pricing moments need to be calibrated simultaneously.
Keywords: Dynamic economies, Uncertainty, Epstein-Zin Preferences
JEL Classification: C32, C63, E32, E44
Suggested Citation: Suggested Citation
Bretscher, Lorenzo and Hsu, Alex C. and Tamoni, Andrea, Risk Aversion and the Response of the Macroeconomy to Uncertainty Shocks (September 8, 2017). Georgia Tech Scheller College of Business Research Paper No. 17-13. Available at SSRN: https://ssrn.com/abstract=2938361 or http://dx.doi.org/10.2139/ssrn.2938361