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Volatility Risk and Economic Welfare

Shaofeng Xu

Staff Working Papers from Bank of Canada

Abstract: This paper examines the effects of time-varying volatility on welfare. I construct a tractable endogenous growth model with recursive preferences, stochastic volatility, and capital adjustment costs. The model shows that a rise in volatility can decelerate growth in the absence of any level shocks. In contrast to level risk, which is always welfare reducing for a risk-averse household, volatility risk can increase or decrease welfare, depending on model parameters. When calibrated to U.S. data, the model finds that the welfare cost of volatility risk is largely negligible under plausible model parameterizations.

Keywords: Business fluctuations and cycles; Economic models (search for similar items in EconPapers)
JEL-codes: E2 E3 (search for similar items in EconPapers)
Pages: 34 pages
Date: 2017
New Economics Papers: this item is included in nep-dcm, nep-dge, nep-mac and nep-rmg
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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:17-20

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