NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Second-Order Approximation of Dynamic Models with Time-Varying Risk

Gianluca Benigno, Pierpaolo Benigno, Salvatore Nisticò

NBER Working Paper No. 16633
Issued in December 2010
NBER Program(s):   EFG   ME   TWP   AP

This paper provides first and second-order approximation methods for the solution of non-linear dynamic stochastic models in which the exogenous state variables follow conditionally-linear stochastic processes displaying time-varying risk. The first-order approximation is consistent with a conditionally-linear model in which risk is still time-varying but has no distinct role -- separated from the primitive stochastic disturbances -- in influencing the endogenous variables. The second-order approximation of the solution, instead, is sufficient to get this role. Moreover, risk premia, evaluated using only a first-order approximation of the solution, will be also time varying.

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Document Object Identifier (DOI): 10.3386/w16633

Published: Benigno, Gianluca & Benigno, Pierpaolo & Nisticò, Salvatore, 2013. "Second-order approximation of dynamic models with time-varying risk," Journal of Economic Dynamics and Control, Elsevier, vol. 37(7), pages 1231-1247.

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