When It Rains It Pours: Cascading Uncertainty Shocks

Abstract

The effects of uncertainty shocks are superadditive. Based on local projections, we find the combination of nearby positive shocks can be multiple times more powerful than the sum of their standalone effects. In a standard New-Keynesian DSGE model, uncertainty shocks are proven to be superadditive only when the model is solved under fourth (or higher) order perturbation. The fourth order solution unlocks the fourth derivative of marginal utility, “edginess”, which is key to generating stronger reactions to multiple risks and superadditivity. Intuitively, an agent already bearing one risk is less willing to bear another in the presence of edginess.

Keywords: Dynamic Equilibrium Economies; Stochastic Volatility; Perturbation; Path dependency..

JEL Classification: C63, C68, E37