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Working Paper
Accounting for Risk in a Linearized Solution: How to Approximate the Risky Steady State and Around It
We propose a novel approximation of the risky steady state and construct first-order perturbations around it for a general class of dynamic equilibrium models with time-varying and non-Gaussian risk. We offer analytical formulas and conditions for their local existence and uniqueness. We apply this approximation technique to models featuring Campbell-Cochrane habits, recursive preferences, and time-varying disaster risk, and show how the proposed approximation represents the implications of the model similarly to global solution methods. We show that our approximation of the risky steady ...
Working Paper
Precautionary Volatility and Asset Prices
Many theories of asset prices assume time-varying uncertainty in order to generate time-varying risk premia. This paper generates time-varying uncertainty endogenously, through precautionary saving dynamics. Precautionary motives prescribe that, in bad times, next period's consumption should be very sensitive to news. This time-varying sensitivity results in time-varying consumption volatility. Production makes this channel visible, and external habit preferences amplify it. An estimated model featuring this channel quantitatively accounts for excess return and dividend predictability ...