TY - JOUR AU - Fernández-Villaverde,Jesús AU - Guerrón-Quintana,Pablo A. AU - Rubio-Ramírez,Juan AU - Uribe,Martín TI - Risk Matters: The Real Effects of Volatility Shocks JF - National Bureau of Economic Research Working Paper Series VL - No. 14875 PY - 2009 Y2 - April 2009 UR - http://www.nber.org/papers/w14875 L1 - http://www.nber.org/papers/w14875.pdf N1 - Author contact info: Jesus Fernandez-Villaverde University of Pennsylvania 160 McNeil Building 3718 Locust Walk Philadelphia, PA 19104 Tel: 267/307-1068 E-Mail: jesusfv@econ.upenn.edu Pablo A. Guerrón-Quintana Federal Reserve Bank of Philadelphia Tel: 9195132869 E-Mail: pablo.guerron@phil.frb.org Juan Rubio-Ramírez Duke University P.O. Box 90097 Durham, NC 27708 Tel: 9196601865 E-Mail: juan.rubio-ramirez@duke.edu Martin Uribe Department of Economics Columbia University International Affairs Building New York, NY 10027 Tel: 212 851 4008 Fax: 212 854 8059 E-Mail: martin.uribe@columbia.edu AB - This paper shows how changes in the volatility of the real interest rate at which small open emerging economies borrow have a quantitatively important effect on real variables like output, consumption, investment, and hours worked. To motivate our investigation, we document the strong evidence of time-varying volatility in the real interest rates faced by a sample of four emerging small open economies: Argentina, Ecuador, Venezuela, and Brazil. We postulate a stochastic volatility process for real interest rates using T-bill rates and country spreads and estimate it with the help of the Particle filter and Bayesian methods. Then, we feed the estimated stochastic volatility process for real interest rates in an otherwise standard small open economy business cycle model. We calibrate eight versions of our model to match basic aggregate observations, two versions for each of the four countries in our sample. We find that an increase in real interest rate volatility triggers a fall in output, consumption, investment, and hours worked, and a notable change in the current account of the economy. ER -