A time varying DSGE model with financial frictions

Ana Beatriz Galvão; Liudas Giraitis; George Kapetanios; Katerina Petrova

doi:10.1016/j.jempfin.2016.02.012

A time varying DSGE model with financial frictions

Ana Beatriz Galvão, Liudas Giraitis, George Kapetanios, Katerina Petrova^*

^*Corresponding author for this work

Research output: Contribution to journal › Article › peer-review

Abstract

We build a time varying DSGE model with financial frictions in order to evaluate changes in the responses of the macroeconomy to financial friction shocks. Using U.S. data, we find that the transmission of the financial friction shock to economic variables, such as output growth, has not changed in the last 30. years. The volatility of the financial friction shock, however, has changed, so that output responses to a one-standard deviation of the shock increase twofold in the 2007-2011 period in comparison with the 1985-2006 period. The time varying DSGE model with financial frictions improves the accuracy of forecasts of output growth and inflation during the tranquil period of 2000-2006, while delivering similar performance to the fixed coefficient DSGE model for the 2007-2012 period.

Original language	English
Pages (from-to)	690–716
Journal	Journal of Empirical Finance
Volume	38
Issue number	B
Early online date	24 Mar 2016
DOIs	https://doi.org/10.1016/j.jempfin.2016.02.012
Publication status	Published - 2 Sept 2016

Keywords

Bayesian methods
DSGE models
Financial frictions
Time varying parameters

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10.1016/j.jempfin.2016.02.012

A time varying DSGE model with financial frictions
Copyright © 2016 Elsevier B.V. This work is made available online in accordance with publisher's policies. This is the author created, accepted version manuscript following peer review and may differ slightly from the final published version. The final published version is available at https://doi.org/10.1016/j.jempfin.2016.02.012
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Cite this

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title = "A time varying DSGE model with financial frictions",

abstract = "We build a time varying DSGE model with financial frictions in order to evaluate changes in the responses of the macroeconomy to financial friction shocks. Using U.S. data, we find that the transmission of the financial friction shock to economic variables, such as output growth, has not changed in the last 30. years. The volatility of the financial friction shock, however, has changed, so that output responses to a one-standard deviation of the shock increase twofold in the 2007-2011 period in comparison with the 1985-2006 period. The time varying DSGE model with financial frictions improves the accuracy of forecasts of output growth and inflation during the tranquil period of 2000-2006, while delivering similar performance to the fixed coefficient DSGE model for the 2007-2012 period.",

keywords = "Bayesian methods, DSGE models, Financial frictions, Time varying parameters",

author = "Galv{\~a}o, {Ana Beatriz} and Liudas Giraitis and George Kapetanios and Katerina Petrova",

note = "Galv{\~a}o, Kapetanios and Petrova acknowledge fnancial support from the ESRC grant No ES/K010611/1.",

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AU - Galvão, Ana Beatriz

AU - Giraitis, Liudas

AU - Kapetanios, George

AU - Petrova, Katerina

N1 - Galvão, Kapetanios and Petrova acknowledge fnancial support from the ESRC grant No ES/K010611/1.

PY - 2016/9/2

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N2 - We build a time varying DSGE model with financial frictions in order to evaluate changes in the responses of the macroeconomy to financial friction shocks. Using U.S. data, we find that the transmission of the financial friction shock to economic variables, such as output growth, has not changed in the last 30. years. The volatility of the financial friction shock, however, has changed, so that output responses to a one-standard deviation of the shock increase twofold in the 2007-2011 period in comparison with the 1985-2006 period. The time varying DSGE model with financial frictions improves the accuracy of forecasts of output growth and inflation during the tranquil period of 2000-2006, while delivering similar performance to the fixed coefficient DSGE model for the 2007-2012 period.

AB - We build a time varying DSGE model with financial frictions in order to evaluate changes in the responses of the macroeconomy to financial friction shocks. Using U.S. data, we find that the transmission of the financial friction shock to economic variables, such as output growth, has not changed in the last 30. years. The volatility of the financial friction shock, however, has changed, so that output responses to a one-standard deviation of the shock increase twofold in the 2007-2011 period in comparison with the 1985-2006 period. The time varying DSGE model with financial frictions improves the accuracy of forecasts of output growth and inflation during the tranquil period of 2000-2006, while delivering similar performance to the fixed coefficient DSGE model for the 2007-2012 period.

KW - Bayesian methods

KW - DSGE models

KW - Financial frictions

KW - Time varying parameters

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A time varying DSGE model with financial frictions

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