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Risk Premia on Equity and Debt in a DSGE Model with Long-Run Real and Nominal Risks

Author

Listed:
  • Eric Swanson

    (Federal Reserve Bank of San Francisco)

  • Glenn Rudebusch

    (Federal Reserve Bank of San Francisco)

Abstract

The risk premium on equities and nominal and real long-term debt in the standard dynamic stochastic general equilibrium (DSGE) model used in macroeconomics is far too small and stable relative to empirical measures obtained from the data--an example of the equity and bond "premium puzzles." However, in models of endowment economies, researchers have been able to generate reasonable risk premiums by assuming that investors have recursive Epstein-Zin preferences and face long-run economic risks. We show that introducing Epstein-Zin preferences into a canonical DSGE model can also produce large and variable risk premiums on these securities without compromising the model's ability to fit key macroeconomic variables. Long-run real and nominal risks further improve the model's ability to fi t the data with a lower level of household risk aversion.

Suggested Citation

  • Eric Swanson & Glenn Rudebusch, 2009. "Risk Premia on Equity and Debt in a DSGE Model with Long-Run Real and Nominal Risks," 2009 Meeting Papers 29, Society for Economic Dynamics.
    • Handle: RePEc:red:sed009:29
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    Cited by:

    1. Zuzana Mucka & Michal Horvath, 2015. "Fiscal Policy Matters A New DSGE Model for Slovakia," Discussion Papers Discussion Paper No. 1/20, Council for Budget Responsibility.

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