Arbeitspapier
Risk Matters: Breaking Certainty Equivalence
In this paper we use the property that certainty equivalence, as implied by a first-order approximation to the solution of stochastic discrete-time models, breaks in its equivalent continuous-time version. We study the extent to which a first-order approximated solution built by perturbation methods accounts for risk. We show that risk matters economically in a real business cycle (RBC) model with habit formation and capital adjustment costs and that neglecting risk leads to substantial pricing errors. A first-order approximation in continuous time reduces pricing errors by 90 percent relative to the certainty equivalent linear solution.
- Sprache
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Englisch
- Erschienen in
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Series: CESifo Working Paper ; No. 8250
- Klassifikation
-
Wirtschaft
Mathematical Methods
Optimization Techniques; Programming Models; Dynamic Analysis
Computational Techniques; Simulation Modeling
General Aggregative Models: Neoclassical
Business Fluctuations; Cycles
Asset Pricing; Trading Volume; Bond Interest Rates
- Thema
-
certainty equivalence
perturbation methods
pricing errors
- Ereignis
-
Geistige Schöpfung
- (wer)
-
Parra-Alvarez, Juan Carlos
Polattimur, Hamza
Posch, Olaf
- Ereignis
-
Veröffentlichung
- (wer)
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Center for Economic Studies and ifo Institute (CESifo)
- (wo)
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Munich
- (wann)
-
2020
- Handle
- Letzte Aktualisierung
-
10.03.2025, 11:42 MEZ
Datenpartner
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Objekttyp
- Arbeitspapier
Beteiligte
- Parra-Alvarez, Juan Carlos
- Polattimur, Hamza
- Posch, Olaf
- Center for Economic Studies and ifo Institute (CESifo)
Entstanden
- 2020