Risk Aversion and the Response of the Macroeconomy to Uncertainty Shocks

72 Pages Posted: 22 Mar 2017 Last revised: 8 Jun 2018

Lorenzo Bretscher

London School of Economics & Political Science (LSE)

Alex Hsu

Georgia Institute of Technology - Scheller College of Business

Andrea Tamoni

London School of Economics & Political Science (LSE)

Date Written: May 17, 2018

Abstract

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 amplifi ed 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

Bretscher, Lorenzo and Hsu, Alex and Tamoni, Andrea, Risk Aversion and the Response of the Macroeconomy to Uncertainty Shocks (May 17, 2018). 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 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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