Understanding Uncertainty Shocks and the Role of Black Swans

44 Pages Posted: 26 Mar 2016

See all articles by Anna Orlik

Anna Orlik

Board of Governors of the Federal Reserve System

Laura Veldkamp

New York University - Stern School of Business; National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: October 22, 2015

Abstract

Economic uncertainty is a powerful force in the modern economy. Recent work shows that surges in uncertainty can trigger business cycles, bank runs and asset price fluctuations. But where do sudden surges in uncertainty come from? This paper provides a data-disciplined theory of belief formation that explains large fluctuations in uncertainty. It argues that people do not know the true distribution of macroeconomic outcomes. Like Bayesian econometricians, they estimate a distribution. Our main contribution is to explain why real-time estimation of distributions with non-normal tails are prone to large uncertainty fluctuations. We use theory and data to show how small changes in estimated skewness whip around probabilities of unobserved tail events (black swans). Our estimates, based on real-time GDP data, reveal that revisions in the estimates of black swan risk explain most of the fluctuations in uncertainty.

Suggested Citation

Orlik, Anna and Veldkamp, Laura, Understanding Uncertainty Shocks and the Role of Black Swans (October 22, 2015). Available at SSRN: https://ssrn.com/abstract=2754317 or http://dx.doi.org/10.2139/ssrn.2754317

Anna Orlik

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Laura Veldkamp (Contact Author)

New York University - Stern School of Business ( email )

44 West 4th St. - Suite 7-180
New York, NY 100012
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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