Risk news shocks and the business cycle

Working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 20 December 2013

Working Paper No. 483
By Gabor Pinter, Konstantinos Theodoridis and Tony Yates 

We identify a ‘risk news' shock in a vector autoregression (VAR), modifying Barsky and Sims’s procedure, while incorporating sign restrictions to simultaneously identify monetary policy, technology and demand shocks. The VAR-identifed risk news shock is estimated to account for around 2%-12% of business cycle fluctuations depending on which risk proxy we use; regardless, contemporaneous risk and risk news shocks together account for about 20%. This is substantially lower than the 60% reported in Christiano, Motto, and Rostagno’s full-information exercise. We fit a DSGE model with financial frictions to these impulse responses and find that, in order to match the fall in consumption recorded by the VAR, we have to allow for 75% of consumers to be living hand-to-mouth.

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