The Finance Uncertainty Multiplier

Fisher College of Business Working Paper No. 2017-03-30

Charles A. Dice Working Paper No. 2017-30

81 Pages Posted: 29 Dec 2017 Last revised: 11 Jan 2019

See all articles by Iván Alfaro

Iván Alfaro

BI Norwegian Business School

Nicholas Bloom

Stanford University - Department of Economics; National Bureau of Economic Research (NBER)

Xiaoji Lin

University of Minnesota

Multiple version iconThere are 2 versions of this paper

Date Written: January 10, 2019

Abstract

We show how real and financial frictions amplify the impact of uncertainty shocks. We build a model with real frictions, and find adding financial frictions roughly doubles the impact of uncertainty shocks. Higher uncertainty alongside financial frictions induces the standard real-options effects on investment and hiring, but also leads firms to hoard cash, further reducing investment and hiring. We then test the model using a panel of US firms and a novel instrumentation strategy for uncertainty exploiting differential firm exposure to exchange rate and price volatility. Using common proxies for financial constraints, we show that ex-ante financially constrained firms cut investment and other real inputs more intensively than unconstrained firms following an uncertainty shock. These results highlight why in periods with greater financial frictions uncertainty can be particularly damaging.

Keywords: Uncertainty, Financial frictions, Investment, Employment, Cash holding, Equity payouts

JEL Classification: D22, E23, E44, G32

Suggested Citation

Alfaro, Iván and Bloom, Nicholas and Lin, Xiaoji, The Finance Uncertainty Multiplier (January 10, 2019). Fisher College of Business Working Paper No. 2017-03-30. Available at SSRN: https://ssrn.com/abstract=3093871 or http://dx.doi.org/10.2139/ssrn.3093871

Iván Alfaro (Contact Author)

BI Norwegian Business School ( email )

Nydalsveien 37
Oslo, 0442
Norway

Nicholas Bloom

Stanford University - Department of Economics ( email )

Landau Economics Building, Room 231
579 Serra Mall
Stanford, CA 94305-6072
United States
650-725-7836 (Phone)

HOME PAGE: http://economics.stanford.edu/faculty/bloom

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Xiaoji Lin

University of Minnesota ( email )

420 Delaware St. SE
Minneapolis, MN 55455
United States

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