Risk Aversion and the Response of the Macroeconomy to Uncertainty Shocks

38 Pages Posted: 22 Mar 2017 Last revised: 12 Apr 2017

Lorenzo Bretscher

London School of Economics & Political Science (LSE)

Alex C. Hsu

Georgia Institute of Technology - Scheller College of Business

Andrea Tamoni

London School of Economics & Political Science (LSE)

Date Written: March 20, 2017

Abstract

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 (2005), from endowment economies to full general equilibrium as macroeconomic and asset pricing moments need to be calibrated simultaneously.

Keywords: Dynamic economies, Uncertainty

JEL Classification: C32, C63, E32, E44

Suggested Citation

Bretscher, Lorenzo and Hsu, Alex C. and Tamoni, Andrea, Risk Aversion and the Response of the Macroeconomy to Uncertainty Shocks (March 20, 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

Lorenzo Bretscher

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

Alex C. Hsu

Georgia Institute of Technology - Scheller College of Business ( email )

800 West Peachtree St.
Atlanta, GA 30308
United States
4043851123 (Phone)

Andrea Tamoni (Contact Author)

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom
02079557303 (Phone)

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