Risk Shocks

Abstract

We augment a standard monetary dynamic general equilibrium model to include a Bernanke-Gertler-Gilchrist financial accelerator mechanism. We fit the model to US data, allowing the volatility of cross-sectional idiosyncratic uncertainty to fluctuate over time. We refer to this measure of volatility as risk. We find that fluctuations in risk are the most important shock driving the business cycle. (JEL D81, D82, E32, E44, L26)We introduce agency problems associated with financial intermediation into an otherwise standard model of business cycles. Our estimates suggest that fluctuations in the severity of these agency problems account for a substantial portion of business cycle fluctuations over the past two and a half decades.The agency problems we introduce are those associated with asymmetric information and costly monitoring proposed by Townsend (1979). Our implementation most closely follows the work of Bernanke and Gertler (1989) and Bernanke, Gertler, and Gilchrist (1999)-henceforth, BGG. 1 Entrepreneurs play a central role in the model. They combine their own resources with loans to acquire raw capital. They then convert raw capital into effective capital in a process that is characterized by idiosyncratic uncertainty. We refer to the magnitude of this uncertainty as risk. The notion that idiosyncratic uncertainty in the allocation of capital is important in practice can be motivated informally in several ways. For example, it is well known that a large 1 Other important early contributions to the role of costly state verification in business cycles include the work of Williamson (1987); Carlstrom and Fuerst (1997);and Fisher (1999). More recent contributions include the work of Christiano, Motto, and Rostagno (

Agency Costs, Risk Shocks, and International Cycles

“…Output, hours worked, investment and consumption in both countries increase in response to a shock in country 1 and have a prominent hump shape. 14 The shape of these responses is not surprising in light of the work of Carlstrom and Fuerst (1997). Figure 1 shows that the response of investment in the home country is slightly weaker when financial frictions are present.…”

Macroeconomic Policy in DSGE and Agent-Based Models Redux: New Developments and Challenges Ahead

“…In the latter case, they provide credit to firms, but as they are constrained by deposits and the resources they can raise in the interbank market, a spread emerges between loan and deposits interest rates (see Christiano et al, 2011Christiano et al, , 2013, for a similar framework where interest rate spread arises from exogenous firms' failure risk). They find that during crises, unconventional monetary policy (i.e.…”

Interpreting volatility shocks as preference shocks

“…K is the optimal consumption function given in (9). Note that q 0 is positive by construction and its value is endogenously determined within the model.…”