In RBC models, “disaster risk shocks” reproduce countercyclical risk premia but generate an increase in consumption along the recession and asset price fall, through their effects on agents’ preferences (Gourio, 2012). This paper offers a solution to this puzzle by developing a New Keynesian model with such a small but time-varying probability of “disaster”. We show that price stickiness, combined with an elasticity of intertemporal substitution smaller than unity, restores procyclical consumption and wages, while preserving countercyclical risk premia, in response to disaster risk shocks. The mechanism then provides a rationale for discount factor first- and second-moment (“uncertainty”) shocks.
|Place of Publication||Paris|
|Publisher||Banque de France|
|Number of pages||59|
|Publication status||Published - 2016|
|MoE publication type||D4 Published development or research report or study|
Fields of Science
- 511 Economics