Risk Matters: Breaking Certainty Equivalence

Publikation: Working paperForskning

Standard

Risk Matters : Breaking Certainty Equivalence. / Parra-Alvarez, Juan Carlos; Polattimur, Hamza; Posch, Olaf.

Aarhus : CREATES, Institut for Økonomi, Aarhus Universitet, 2020.

Publikation: Working paperForskning

Harvard

Parra-Alvarez, JC, Polattimur, H & Posch, O 2020 'Risk Matters: Breaking Certainty Equivalence' CREATES, Institut for Økonomi, Aarhus Universitet, Aarhus.

APA

Parra-Alvarez, J. C., Polattimur, H., & Posch, O. (2020). Risk Matters: Breaking Certainty Equivalence. CREATES, Institut for Økonomi, Aarhus Universitet. CREATES Research Papers, Nr. 2020-02

CBE

Parra-Alvarez JC, Polattimur H, Posch O. 2020. Risk Matters: Breaking Certainty Equivalence. Aarhus: CREATES, Institut for Økonomi, Aarhus Universitet.

MLA

Parra-Alvarez, Juan Carlos, Hamza Polattimur, og Olaf Posch Risk Matters: Breaking Certainty Equivalence. Aarhus: CREATES, Institut for Økonomi, Aarhus Universitet. (CREATES Research Papers; Journal nr. 2020-02). 2020., 45 s.

Vancouver

Parra-Alvarez JC, Polattimur H, Posch O. Risk Matters: Breaking Certainty Equivalence. Aarhus: CREATES, Institut for Økonomi, Aarhus Universitet. 2020 mar.

Author

Parra-Alvarez, Juan Carlos ; Polattimur, Hamza ; Posch, Olaf. / Risk Matters : Breaking Certainty Equivalence. Aarhus : CREATES, Institut for Økonomi, Aarhus Universitet, 2020. (CREATES Research Papers; Nr. 2020-02).

Bibtex

@techreport{eef83ac70cf74e7e9d41be6c6bb3ed93,
title = "Risk Matters: Breaking Certainty Equivalence",
abstract = "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.",
keywords = "Certainty equivalence, Perturbation methods, Pricing errors",
author = "Parra-Alvarez, {Juan Carlos} and Hamza Polattimur and Olaf Posch",
year = "2020",
month = mar,
language = "English",
series = "CREATES Research Papers",
publisher = "CREATES, Institut for {\O}konomi, Aarhus Universitet",
number = "2020-02",
type = "WorkingPaper",
institution = "CREATES, Institut for {\O}konomi, Aarhus Universitet",

}

RIS

TY - UNPB

T1 - Risk Matters

T2 - Breaking Certainty Equivalence

AU - Parra-Alvarez, Juan Carlos

AU - Polattimur, Hamza

AU - Posch, Olaf

PY - 2020/3

Y1 - 2020/3

N2 - 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.

AB - 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.

KW - Certainty equivalence

KW - Perturbation methods

KW - Pricing errors

M3 - Working paper

T3 - CREATES Research Papers

BT - Risk Matters

PB - CREATES, Institut for Økonomi, Aarhus Universitet

CY - Aarhus

ER -