Uncertainty Shocks and Firm Dynamics

Paper Session

Saturday, Jan. 7, 2017 3:15 PM – 5:15 PM

Hyatt Regency Chicago, Burnham
Hosted By: Econometric Society
  • Chair: Shaofeng Xu, Bank of Canada

Volatility Risk and Economic Welfare

Shaofeng Xu
Bank of Canada


This paper examines whether the presence of time-variation in uncertainty by itself increases or decreases welfare. I construct an analytically tractable endogenous growth model featuring recursive preferences, stochastic volatility, and costly capital adjustment. The model shows explicitly that a rise in volatility can decelerate growth in the absence of any level shocks. In contrast to level risk, which is always welfare reducing for a risk-averse household, volatility risk can either increase or decrease welfare, depending on the size of risk aversion relative to unity. When calibrated to U.S. data, the model finds that volatility risk is virtually welfare neutral under plausible model parameterizations.

Uncertainty, Heterogeneous Beliefs, and Business Cycles: Macro and Micro Evidence

Dun Jia
Renmin University of China


This paper provides empirical evidence both at the aggregate and the micro level to demonstrate that the survey-based forecast dispersion series helps identify a different type of second moment shocks, which affect the distribution of firms' beliefs regardless of whether those beliefs are backed by economic fundamentals. Having jointly identified the ``informational disagreement shocks" and the standard uncertainty shocks, innovations that enlarge the forecast dispersion lead to a persistent decline in aggregate investment, employment, and production followed by a slow recovery. Conversely, when the uncertainty is measured by the variability of future firm-specific productivity innovations, the classic ``wait and see" effect of uncertainty kicks in such that a quick ``rebound-overshoot" ensuing a short-run contraction. Firm-level evidence suggests that those more productive firms increase the investments given larger uncertainty, whereas the investments are cut when they hold more heterogeneous beliefs about future business well-beings. Thus, the heightened uncertainty promotes while rises in the belief heterogeneity hinders the capital reallocation among firms. The results hold with the endogeneity issue corrected with instruments constructed from the USPTO patent data. It implies that the recession and a slow recovery can be a result of second moment shocks to non-fundamentals only.

Global Spillover Effects of US Uncertainty

Saroj Bhattarai
University of Texas-Austin
Arpita Chatterjee
University of New South Wales
Woong Yong Park
Seoul National University


We study the spillover effects of fluctuations in US uncertainty. Using monthly panel data from fifteen major emerging market economies (EMEs), we show that an unanticipated rise in US stock market uncertainty has negative effects on their stock prices and exchange rate, increases long-term interest rate spreads, and leads to capital outflows. These negative financial effects transmit to the real economy as a drop in output, a rise in consumer prices, and a rise in net exports from these countries. The negative effects on output, exchange rates, and stock prices are weaker, but the effects on capital flows and trade flows stronger, for South American countries compared to other EMEs. We present a small open economy (SOE) model that can account for our empirical findings. A negative external shock that increases the interest rate spread faced by the SOE produces responses of macroeconomic and financial variables that are consistent with our estimated responses. The model can also account for the heterogeneity in responses across countries depending on the endogenous response of the monetary policy instrument to the increase in interest rate spread.
JEL Classifications
  • E0 - General