Welfare Costs, Long Run Consumption Risk, and a Production Economy.
Mariano M. Croce
The main goal of this paper is to measure the welfare costs of
business cycles in a production economy in which the representative
agent has low risk aversion and - at the same time - the equity
premium and the co-movements of aggregate quantities and market
returns are comparable to what observed in historical data. In order
to do so, I consider a production economy in which the
representative agent has Epstein-Zin-Weil(1989) preferences,
productivity has a Long Run Risk component and there are capital
adjustment costs. In this way, I try to bridge the gap between the
current Long Run Risk asset pricing literature, in which quantities
are taken as exogenous, and the standard macroeconomic business
cycle models. Preliminary results from a benchmark exchange economy
suggest that when there is a Long Run Consumption Risk and the
representative agent prefers early resolution of uncertainty, the
implied total welfare costs of the consumption uncertainty range
from 12\% to 20\%. (JEL classification: E20, E32, G12, D81)
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