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Studies in Nonlinear Dynamics & Econometrics

Ed. by Mizrach, Bruce


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Volume 24 (2020)

Risk shocks with time-varying higher moments

Victor Dorofeenko / Gabriel Lee / Kevin Salyer / Johannes StrobelORCID iD: https://orcid.org/0000-0002-4989-3554
Published Online: 2019-04-11 | DOI: https://doi.org/10.1515/snde-2018-0028

Abstract

Within the context of a financial accelerator model, we model time-varying uncertainty (i.e. risk shocks) through the use of a mixture normal model with time variation in the weights applied to the underlying distributions characterizing entrepreneur productivity. Specifically, we model capital producers (i.e. the entrepreneurs) as either low-risk (a relatively small second moment of productivity) or high-risk (a relatively large second moment of productivity) and the fraction of both types is time-varying. We show that this modeling feature implies that the aggregate distribution of productivity shocks is non-normal and has time varying kurtosis and skewness; both of these features have important effects on equilibrium characteristics. In particular, after estimating the steady-state share and the change in the fraction of risky entrepreneurs, we show that a small change in the fraction of risky types can result in a large quantitative effect of a risk shock relative to standard models for both financial and real variables. Moreover, the bankruptcy rate and the risk premium in the economy are very sensitive to a change in the composition of entrepreneurs.

This article offers supplementary material which is provided at the end of the article.

Keywords: bankruptcy rate; Bayesian analysis; DSGE models; mixture models; time-varying uncertainty

JEL Classification: C11; E22; E32

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Published Online: 2019-04-11


Citation Information: Studies in Nonlinear Dynamics & Econometrics, 20180028, ISSN (Online) 1558-3708, DOI: https://doi.org/10.1515/snde-2018-0028.

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