Second-Order Approximation of Dynamic Models with Time-Varying Risk
This paper provides first and second-order approximation methods for the solution of non-linear dynamic stochastic models in which the exogenous state variables follow conditionally-linear stochastic processes displaying time-varying risk. The first-order approximation is consistent with a conditionally-linear model in which risk is still time-varying but has no distinct role - separated from the primitive stochastic disturbances - in influencing the endogenous variables. The second-order approximation of the solution, instead, is sufficient to get this role. Moreover, risk premia, evaluated using only a first-order approximation of the solution, will be also time varying.
Year of publication: |
2010
|
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Authors: | Benigno, Gianluca ; Benigno, Pierpaolo ; Nisticò, Salvatore |
Institutions: | Istituto Einaudi per l'Economia e la Finanza (EIEF) |
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