Risk Aversion Sensitive Real Business Cycles
48 Pages Posted: 8 Oct 2012 Last revised: 16 May 2019
Date Written: April 2019
Technology choice allows for substitution of production across states of nature and depends on state dependent risk aversion. In equilibrium, endogenous technology choice can counter a persistent negative productivity shock with an increase in investment. An increase in risk aversion intensifies transformation across states, which directly leads to higher investment volatility. In our model and the data, the conditional volatility of investment correlates negatively with the price-dividend ratio and predicts excess stock market returns. In addition, the same mechanism generates predictability of consumption and produces fluctuations in the risk-free rate.
Keywords: State-contingent technology; Time-varying risk aversion; Conditional volatility of investment; Predictability of returns
JEL Classification: E23, E32, E37, G12
Suggested Citation: Suggested Citation