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Second-order approximation of dynamic models with time-varying risk

Benigno, Gianluca, Benigno, Pierpaolo and Nisticò, Salvatore (2011) Second-order approximation of dynamic models with time-varying risk. Financial Markets Group Discussion Papers (677). Financial Markets Group, The London School of Economics and Political Science, London, UK.

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Abstract

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.

Item Type: Monograph (Discussion Paper)
Official URL: https://www.fmg.ac.uk/
Additional Information: © 2011 The Authors
Divisions: Economics
Subjects: H Social Sciences > HC Economic History and Conditions
H Social Sciences > HG Finance
JEL classification: C - Mathematical and Quantitative Methods > C6 - Mathematical Methods and Programming > C63 - Computational Techniques
Date Deposited: 29 Jun 2023 14:48
Last Modified: 16 May 2024 12:29
URI: http://eprints.lse.ac.uk/id/eprint/119071

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