Risk Aversion and the Response of the Macroeconomy to Uncertainty Shocks
72 Pages Posted: 22 Mar 2017 Last revised: 8 Jun 2018
Date Written: May 17, 2018
Degree of risk aversion (RA) determines the impact of second moment shocks in DSGE models featuring stochastic volatility. Ceteris paribus, a higher coefficient of risk aversion leads to an amplification of macroeconomic responses to uncertainty shocks in standard New Keynesian models. This effect is even larger when the model economy features habit-induced time-varying RA. Empirically, and consistent with model predictions, we show that RA exacerbates the impact of uncertainty shocks. In particular, heightened level of RA during the 2008 crisis amplified the drop in output and investment by 21% and 16%, respectively, at the recession trough.
Keywords: Risk Aversion, Uncertainty, Conditional IRF, Dynamic Economies.
JEL Classification: C32, C63, E32, E44
Suggested Citation: Suggested Citation