Understanding Uncertainty Shocks and the Role of Black Swans / Anna Orlik, Laura Veldkamp.

Format:

Book

Author/Creator:

Orlik, Anna.

Contributor:

National Bureau of Economic Research.

Veldkamp, Laura.

Series:

Working Paper Series (National Bureau of Economic Research) no. w20445.

NBER working paper series no. w20445

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2014.

Summary:

A fruitful emerging literature reveals that shocks to uncertainty can explain asset returns, business cycles and financial crises. The literature equates uncertainty shocks with changes in the variance of an innovation whose distribution is common knowledge. But how do such shocks arise? This paper argues that people do not know the true distribution of macroeconomic outcomes. Like Bayesian econometricians, they estimate a distribution. Using real-time GDP data, we measure uncertainty as the conditional standard deviation of GDP growth, which captures uncertainty about the distributions estimated parameters. When the forecasting model admits only normally-distributed outcomes, we find small, acyclical changes in uncertainty. But when agents can also estimate parameters that regulate skewness, uncertainty fluctuations become large and counter-cyclical. The reason is that small changes in estimated skewness whip around probabilities of unobserved tail events (black swans). The resulting forecasts resemble those of professional forecasters. Our uncertainty estimates reveal that revisions in parameter estimates, especially those that affect the risk of a black swan, explain most of the shocks to uncertainty.

Notes:

Print version record

August 2014.