On Risk Aversion and News Shocks

Francetic, Igor (2016) On Risk Aversion and News Shocks. Masters thesis, Université de Lausanne.

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Among the different causes of economic booms and downturns put forward by economists,the animal spirits" made famous by J.M. Keynes only �nd little space in the literature.As a result, other implications linked to similar views of business cycles are also generallyneglected by researchers. This is the case for the effects of waves of optimism or pes-simism on the agent's attitudes towards risk (i.e. risk aversion).Our thesis tries to bridge the gap analyzing one possible way to explain animal spirits",that is as news shocks generating expectation swings that ultimately drive economic cy-cles. Furthermore, we assess the relationship between expectation driven booms and riskaversion. Our goal is to understand whether empirical evidence and theoretical modelscan support our intuition, namely that during periods of (aggregate) optimism agentsshould be more incline to bear risks and thus less risk averse.The topic is �rst analyzed through an empirical inspection that basically supports ourinitial hypotheses. Afterwards, building on existing literature, two theoretical (DSGE)models incorporating an expectation driven boom mechanism are developed and simu-lated. Finally, the theoretical models are tested in their implications for risk aversion.Putting aside a slight delay in the response of model-based risk aversion to news shockscompared to the empirical counterparts, our results are qualitatively in line with boththe \news driven business cycles" hypothesis and the idea that news shocks have negativeimpact on aggregate risk aversion.

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