Fat-tailed DSGE models: A survey and new results

Abstract

We review recent advances in dynamic stochastic general equilibrium theory concerned with the emergence of fat-tailed time-series distributions. Focusing on mechanisms that are firmly grounded in structural equilibrium models, we provide a common reference framework to organize existing contributions according to whether they entail extreme business cycle swings as an endogenous response to small and short-lived shocks (“thin in, fat out”), or rather as an automatic consequence of large and/or heteroskedastic exogenous impulses (“fat in, fat out”). Within the former class, non-Gaussian features of equilibrium patterns can endogenously emerge in fully rational, Gaussian environments. Using an empirically plausible real business cycle framework, we also report novel simulation-based evidence that helps reconcile theoretical predictions with the documented higher-order properties of time-series data for output measures.