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Uncertainty and Financial Markets

Paper Session

Friday, Jan. 4, 2019 8:00 AM - 10:00 AM

Atlanta Marriott Marquis, M304
Hosted By: American Economic Association
  • Chair: Scott Ross Baker, Northwestern University

Uncertainty, Financial Frictions, and Investment Dynamics

Simon Gilchrist
,
Boston University
Jae W. Sim
,
Federal Reserve Board
Egon Zakrajsek
,
Federal Reserve Board

Abstract

Micro- and macro-level evidence indicates that fluctuations in idiosyncratic uncertainty have
a large effect on investment; the impact of uncertainty on investment occurs primarily through
changes in credit spreads; and innovations in credit spreads have a strong effect on investment,
irrespective of the level of uncertainty. These findings raise a question regarding the
economic significance of the traditional “wait-and-see” effect of uncertainty shocks and point
to financial distortions as the main mechanism through which fluctuations in uncertainty affect
macroeconomic outcomes. The relative importance of these two mechanisms is analyzed within
a quantitative general equilibrium model, featuring heterogeneous firms that face time-varying
idiosyncratic uncertainty, irreversibility, nonconvex capital adjustment costs, and financial frictions.
The model successfully replicates the stylized facts concerning the macroeconomic implications
of uncertainty and financial shocks. By influencing the effective supply of credit, both
types of shocks exert a powerful effect on investment and generate countercyclical credit spreads
and procyclical leverage, dynamics consistent with the data and counter to those implied by the
technology-driven real business cycle models.

Hedging macroeconomic and financial uncertainty and volatility

Ian Dew-Becker
,
Northwestern University
Stefano Giglio
,
Yale University
Bryan Kelly
,
Yale University

Abstract

This paper studies the pricing of shocks to uncertainty and realized volatility using options contracts directly related to the state of the macroeconomy and of financial markets. Contracts that provide protection against shocks to macroeconomic uncertainty have historically earned statistically and economically significantly positive excess returns. If uncertainty shocks were viewed as bad by investors – in the sense of being associated with high marginal utility – portfolios that hedge them should instead earn negative premia. Portfolios exposed to the realization (as opposed to the expectation) of large shocks to fundamentals, on the other hand, have historically earned large and negative risk premia. These results imply that it is large realizations of shocks to fundamentals, not forward-looking uncertainty shocks, that drive investors’ marginal utility; in turn, these implications can be used to guide and discipline the role of volatility in macroeconomic models.

Uncertainty and Change: Survey Evidence of Firms’ Subjective Beliefs

Ruediger Bachmann
,
University of Notre Dame
Kai Carstensen
,
Institute for Statistics and Econometrics
Stefan Lautenbacher
,
Ifo Institute
Martin Schneider
,
Stanford University

Abstract

This paper provides evidence on firms’ perceived uncertainty about future sales

growth. We exploit a new survey module in the ifo Business Tendency Survey to

develop a representative panel data set of firms’ subjective beliefs, characteristics

and performance for the German manufacturing sector. We then document how

subjective uncertainty varies in the time series as well as in the cross section of

firms. Our main result is that uncertainty reflects change: both at high frequencies

and over the medium term, realized change, either good or bad, makes firms more

uncertain. At the same time, subjective uncertainty differs significantly from conditional

volatility measured by an econometrician, both in the time series and the

cross section.

What Triggers Large Stock Market Jumps?

Scott Ross Baker
,
Northwestern University
Nicholas Bloom
,
Stanford University
Steven J. Davis
,
University of Chicago
Marco Sammon
,
Northwestern University

Abstract

Based on readings of next-day newspaper articles, we catalog the proximate cause and geographic source of all largest 1% of daily stock market movements in 14 countries over the past 30 years. Our catalog extends back to 1930 for the United Kingdom and to 1900 for the United States. Using the United States as a test case, we compare categorizations across several newspapers and human coders, obtaining consistent results. News about the United States plays a disproportionate role in triggering large equity moves around the world in recent decades, relative to the U.S. share of world output. The reverse pattern, of large U.S. equity moves in response to foreign news, is comparatively rare. We show that shocks of different types and geographic origins are associated with significant differences in returns and both implied and realized volatility.
JEL Classifications
  • G1 - General Financial Markets
  • E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook