The Finance Uncertainty Multiplier

80 Pages Posted: 29 Dec 2017 Last revised: 27 Oct 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: October 26, 2019

Abstract

We show how real and financial frictions amplify, prolong and propagate the impact of uncertainty shocks. We first use a novel instrumentation strategy to address endogeneity in estimating the impact of uncertainty, by exploiting differential firm exposure to exchange rate, policy, treasury, and energy price volatility in a panel of US firms. Furthermore, using common proxies for financial constraints, we show that ex-ante financially constrained firms cut their investment more than unconstrained firms following an uncertainty shock. We then build a model with real and financial frictions. We show that adding financial frictions: i) amplifies uncertainty shocks by doubling their impact on output; ii) increases persistence by doubling the duration of the drop; and iii) propagates uncertainty shocks by spreading their impact onto financial variables. These results highlight why in periods of 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 (October 26, 2019). 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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