Uncertainty shocks in a model of effective demand : comment

Basu and Bundick, 2017 showed an intertemporal preference volatility shock has meaningful effects on real activity in a New Keynesian model with Epstein and Zin, 1991 preferences. We show that when the distributional weights on current and future utility in the Epstein–Zin time aggregator do not sum to 1, there is an asymptote in the responses to such a shock with unit intertemporal elasticity of substitution. In the Basu–Bundick model, the intertemporal elasticity of substitution is set near unity and the preference shock only hits current utility, so the sum of the weights differs from 1. We show that when we restrict the weights to sum to 1, the asymptote disappears and preference volatility shocks no longer have large effects. We examine several different calibrations and preferences as potential resolutions with varying degrees of success.PostprintPeer reviewe

Valuation risk revalued

This paper shows the recent success of valuation risk (time-preference shocks in Epstein- Zin utility) in resolving asset pricing puzzles rests sensitively on an undesirable asymptote that occurs because the preference specification fails to satisfy a key restriction on the weights in the Epstein-Zin time-aggregator. In a Bansal-Yaron long-run risk model, our revised valuation risk specification that satisfies the restriction provides a superior empirical fit. The results also show that valuation risk no longer has a major role in matching the mean equity premium and risk-free rate but is crucial for matching the volatility and autocorrelation of the risk-free rate.Publisher PD

Are Nonlinear Methods Necessary at the Zero Lower Bound? Are Nonlinear Methods Necessary at the Zero Lower Bound? *

ABSTRACT This paper examines the importance of using nonlinear methods to account for the zero lower bound (ZLB) on the Fed's policy rate. We estimate three models with a particle filter: (1) a nonlinear model with a ZLB constraint; (2) a constrained linear model that imposes the constraint in the filter but not the solution; and (3) an unconstrained linear model that never imposes the constraint. The linear models have a lower likelihood than the nonlinear model when the Fed is constrained and predict large monetary policy shocks during the ZLB period. We also compare the predictions from our nonlinear model to the quasi-linear solution with OccBin. OccBin captures the ZLB much better than the linear solutions but it still generates less endogenous volatility than the nonlinear model and it is not as conducive to estimation. Finally, we extend the baseline model to include a banking sector. We find larger differences between the predictions from the nonlinear model and both the linear and quasi-linear models