The non-linear nature of country risk and its implications for DSGE models

Michal Brzoza-Brzezina and Jacek Kotłowski

No 2018-035, KAE Working Papers from Warsaw School of Economics, Collegium of Economic Analysis

Abstract: Country risk premia can substantially affect macroeconomic dynamics. We concentrate on one of their most important determinants - a country’s net foreign asset position and - in contrast to the existing research - investigate its nonlinear link to risk premia. The importance of this particular non-linearity is twofold. First, it allows to identify the NFA level above which the elasticity becomes much (possibly dangerously) higher. Second, such a non-linear relationship is a standard ingredient of DSGE models, but its proper calibration/ estimation is missing. Our estimation shows that indeed the link is highly nonlinear and helps to identify the NFA position where the non-linearity kicks in at approximately -70% to -75% of GDP. We also provide a proper calibration of the risk premium - NFA relationship which can be used in DSGE models and demonstrate that its slope matters significantly for economic dynamics in such a model.

Keywords: Risk premium; PSTR model; open economy DSGE model (search for similar items in EconPapers)
JEL-codes: C23 E43 E44 (search for similar items in EconPapers)
Pages: 34 pages
Date: 2018-05
New Economics Papers: this item is included in nep-dge, nep-mac and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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http://hdl.handle.net/20.500.12182/1163 (application/pdf)

Related works:
Journal Article: THE NONLINEAR NATURE OF COUNTRY RISK AND ITS IMPLICATIONS FOR DSGE MODELS (2020)
Working Paper: The nonlinear nature of country risk and its implications for DSGE models (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:sgh:kaewps:2018035

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