Risk Aversion and Real Economic Activity: A Macro-Finance Perspective

Abstract

The novel finding of this paper is that time-varying risk aversion implied by an external habit macro-finance model predicts macroeconomic dynamics both in-sample and out-of-sample across different forecasting horizons. An increase (decrease) in risk aversion forecasts a decrease (increase) in real economic activity. The results are robust after controlling for standard predictors of macroeconomic fluctuations and stable over time.

Keywords: time-varying risk aversion, surplus consumption ratio, real economic activity, prediction, macroeconomic dynamic

JEL Classification: C58, E44, G12