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.
- Language
-
Englisch
- Bibliographic citation
-
Series: CESifo Working Paper ; No. 8250
- Classification
-
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
- Subject
-
certainty equivalence
perturbation methods
pricing errors
- Event
-
Geistige Schöpfung
- (who)
-
Parra-Alvarez, Juan Carlos
Polattimur, Hamza
Posch, Olaf
- Event
-
Veröffentlichung
- (who)
-
Center for Economic Studies and ifo Institute (CESifo)
- (where)
-
Munich
- (when)
-
2020
- Handle
- Last update
-
10.03.2025, 11:42 AM CET
Data provider
This object is provided by:
ZBW - Deutsche Zentralbibliothek für Wirtschaftswissenschaften - Leibniz-Informationszentrum Wirtschaft. If you have any questions about the object, please contact the data provider.
ZBW - Deutsche Zentralbibliothek für Wirtschaftswissenschaften - Leibniz-Informationszentrum Wirtschaft. If you have any questions about the object, please contact the data provider.
Object type
- Arbeitspapier
Associated
- Parra-Alvarez, Juan Carlos
- Polattimur, Hamza
- Posch, Olaf
- Center for Economic Studies and ifo Institute (CESifo)
Time of origin
- 2020
Other Objects (12)
Certainty Equivalence Procedures in the Macroeconomic Planning of an Oil Economy
Non-standard Central Bank loss functions, skewed risks, and certainty equivalence
Non-standard central bank loss functions, skewed risks, and certainty equivalence
Certainty Equivalence Procedures in Decision Making under Uncertainty: An Empirical Application
Indirect adaptive higher-order sliding-mode control using the certainty-equivalence principle
On Certainty
Covariance Structure Behind Breaking of Ensemble Equivalence in Random Graphs
Majority opinion diffusion: when tie-breaking rule matters
Certainty of punishmet.
On losing certainty
Change--The Third Certainty
The search for certainty
Certainty Equivalence Procedures in the Macroeconomic Planning of an Oil Economy
Non-standard Central Bank loss functions, skewed risks, and certainty equivalence
Non-standard central bank loss functions, skewed risks, and certainty equivalence
Certainty Equivalence Procedures in Decision Making under Uncertainty: An Empirical Application
Indirect adaptive higher-order sliding-mode control using the certainty-equivalence principle
On Certainty
Covariance Structure Behind Breaking of Ensemble Equivalence in Random Graphs
Majority opinion diffusion: when tie-breaking rule matters
Certainty of punishmet.
On losing certainty
Change--The Third Certainty
The search for certainty
Certainty Equivalence Procedures in the Macroeconomic Planning of an Oil Economy
Non-standard Central Bank loss functions, skewed risks, and certainty equivalence
Non-standard central bank loss functions, skewed risks, and certainty equivalence
Certainty Equivalence Procedures in Decision Making under Uncertainty: An Empirical Application
Indirect adaptive higher-order sliding-mode control using the certainty-equivalence principle
On Certainty
Covariance Structure Behind Breaking of Ensemble Equivalence in Random Graphs
Majority opinion diffusion: when tie-breaking rule matters
Certainty of punishmet.
On losing certainty
Change--The Third Certainty