A DSGE Model with loss aversion in consumption and leisure: An explanation for business cycles aymmetries

Abstract: In this paper, an asymmetric DSGE model is built in order to account for asymmetries in business cycles. One of the most important contributions of this work is the construcion of a general utility function which nests loss aversion, risk aversion and habits formation, by means of a smooth transition function. The main idea behind this asymmetric utility funcion is that under a recession, the agents over-smooth consumption and leisure choices in order to avoid a huge departure of them from the reference level of the utility; while under a boom, the agents simply smooth consumption and leisure but trying to be as far as possible from the reference level of utility. The simulations of this model by means of Perturbations Method show that it is possible to reproduce asymmetrical business cycles where recession (on shock) are stronger than booms and booms are more long lasting than recession. One additional and unexpected result is a downward stickyness shown by real wages and as consequence of this, a more persistente fall in employment in recession than in boom. Thus the model reproduces not only asymmetrical business cycles but also real stickyness and hysteresis.