Variations in Risk as a Cause of Fluctuations in Demand: The Empirics
1993 (English)Report (Other academic)
In a previous paper (Hassler, 1993) I have extended a standard irreversible investment model to the case when risk if known to stochastically fluctuate between two levels. The model is able to generate substantial fluctuations in durables demand if the level of risk is volatile enough. In this paper I estimate a model where risk, defined as the volatility of wealth, fluctuates between two levels. The risk levels and the transition probabilities are estimated using a maximum likelihood method and US aggregate data. Thereafter the likelihood that the U.S. economy is in the high risk state is estimated for each month from 1959 and 1992. These likelihoods are then used to predict the relative level of durables demand. Durables demand is found to be sensitive to the level of financial volatility. A shift to the high level of financial volatility cause an immediate fall in durables purchases of approximately 3%. Car purchases fall by around 7%. The dynamic response to shifts in risk, is not found to be in line with an irreversibility model with only two levels of risk.
Place, publisher, year, edition, pages
Stockholm: IIES , 1993. , 35 p.
Seminar Paper / Institute for International Economic Studies, Stockholm University, ISSN 0347-8769 ; 554
IdentifiersURN: urn:nbn:se:su:diva-41874OAI: oai:DiVA.org:su-41874DiVA: diva2:338082