De Graeve, Ferre Dossche, Maarten Emiris, Marina Sneessens, Henri Wouters, Raf
Year of Publication:
Working Paper Research 150
We analyze financial risk premiums and real economic dynamics in a DSGE model with three types of agents - shareholders, bondholders and workers - that differ in participation in the capital market and in terms of risk aversion. Aggregate productivity and distribution risk are shared among these agents via the bond market and via an efficient labor contract. The result is a combination of volatile returns to capital and a highly cyclical consumption process for the shareholders, which are two important ingredients for generating high and countercyclical risk premiums. These risk premiums are consistent with a strong propagation mechanism through an elastic supply of labor, rigid real wages and a countercyclical labor share. We discuss the implications for the real and nominal component of the risk premium on equity and bonds. We show how these premiums react to changes in the volatility of the shocks, as experienced during the great moderation. We also analyze the effects of changes in monetary policy behavior and the resulting inflation dynamics.