Uncertainty Shocks in a Model of Effective Demand: Comment

Oliver de Groot, Alexander Richter and Nathaniel Throckmorton

No 1706, Working Papers from Federal Reserve Bank of Dallas

Abstract: Basu and Bundick (2017) show a second moment intertemporal preference shock creates meaningful declines in output in a sticky price model with Epstein and Zin (1991) preferences. The result, however, rests on the way they model the shock. If a preference shock is included in Epstein-Zin preferences, the distributional weights on current and future utility must sum to 1, otherwise it creates an asymptote in the response to the shock with unit intertemporal elasticity of substitution. When we change the preferences so the weights sum to 1, the asymptote disappears as well as their main results—uncertainty shocks generate small increases in output and comovement with consumption and investment that is at odds with the data. We examine three changes to the model—recalibration, a risk-premium shock, and a disaster risk-type shock—to try and restore their results, but in all three cases the model is unable to match VAR evidence.

Keywords: Stochastic Volatility; Epstein-Zin Preferences; Uncertainty; Economic Activity (search for similar items in EconPapers)
JEL-codes: D81 E32 (search for similar items in EconPapers)
Pages: 15 pages
Date: 2017-05-19
New Economics Papers: this item is included in nep-dcm and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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Journal Article: Uncertainty Shocks in a Model of Effective Demand: Comment (2018)
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DOI: 10.24149/wp1706

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