Risk-Sensitive Real Business Cycles

Abstract

This paper considers the business cycle, asset pricing, and welfare effects of increased risk aversion, while holding intertemporal substitution preferences constant. I show that increasing risk aversion does not significantly affect the relative variabilities and co-movements of aggregate quantity variables. At the same time, it dramatically improves the model's asset market predictions. The welfare costs of business cycles increase when preference parameters are chosen to match financial data.

Keyword(s): Business cycles; Asset pricing; Non-expected utility

JEL Classification: E32; G12; D81