Risk aversion in the Eurozone

• We propose a New Keynesian DSGE model with a microfounded risk aversion shock.
• We estimate through Bayesian techniques the model over five different periods.
• Our analysis suggests that risk aversion was an important component of output and real money balance dynamics between 2006 and 2011.
• Controlling shocks to the agents’ risk aversion should not be overlooked.

We propose a New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model where a risk aversion shock enters a separable utility function. We analyze five periods from 1971 through 2011, each lasting for 20 years, to follow over time the dynamics of several parameters such as the risk aversion parameter; the Taylor rule coefficients; and the role of the risk aversion shock in output, inflation, interest rate, and real money balances in the Eurozone. Our analysis suggests that risk aversion was a more important component of output and real money balance dynamics between 2006 and 2011 than it was between 1971 and 2006, at least in the short run.