Managing macrofinancial risk

by Tobias Adrian and Francis Vitek

We augment a linearized dynamic stochastic general equilibrium (DSGE) model with a tractable endogenous risk mechanism, to support the joint analysis of monetary and macroprudential policy. This state dependent conditional heteroskedasticity mechanism specifies the conditional variances of structural shocks as functions of the business or financial cycle. The resultant heteroskedastic linearized DSGE model preserves the satisfactory simulation and forecasting performance of its nested homoskedastic counterpart for the conditional means of endogenous variables, while substantially improving its goodness of fit to their conditional distributions. In particular, the model matches the key stylized facts of growth at risk. Accounting for state dependent conditional heteroskedasticity makes it optimal for monetary policy to respond more aggressively to the business cycle, and for macroprudential policy to manage the resilience of the banking sector more actively over the financial cycle

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Year of publication:	2020
Authors:	Adrian, Tobias ; Vitek, Francis
Publisher:	[Washington, DC] : International Monetary Fund
Subject:	Monetary policy \| Macroprudential policy \| Endogenous risk \| Business cycle \| Financial cycle \| Growth at risk \| Dynamic stochastic general equilibrium model \| State dependent conditional heteroskedasticity \| Geldpolitik \| Konjunktur \| Risiko \| Risk \| Finanzmarktaufsicht \| Financial supervision \| Volatilität \| Volatility \| DSGE-Modell \| DSGE model \| Risikomanagement \| Risk management \| Dynamisches Gleichgewicht \| Dynamic equilibrium \| Finanzmarkt \| Financial market \| Real-Business-Cycle-Theorie \| Real business cycle model