When It Rains It Pours: Cascading Uncertainty Shocks

42 Pages Posted: 30 Jul 2019

See all articles by Anthony M. Diercks

Anthony M. Diercks

Board of Governors of the Federal Reserve System: Monetary and Financial Market Analysis

Alex Hsu

Georgia Institute of Technology - Scheller College of Business

Andrea Tamoni

Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick; London School of Economics & Political Science (LSE)

Date Written: July 26, 2019

Abstract

Uncertainty shocks can be self-reinforcing. We empirically document that serial uncertainty shocks are (1) common in the data and (2) have an increasingly stronger impact on the macroeconomy. In other words, a series of bad (positive) uncertainty shocks exacerbates the economic decline significantly. We then generate the cascading effect of uncertainty shocks in a standard DSGE model. Related to this finding is the non-linear scaling effect of larger positive uncertainty shocks. As the size of the positive shock doubles, the macroeconomic response more than doubles. Standard theoretical models solved under third order perturbation cannot generate these empirical results: a fourth order perturbation solution is crucial.

Keywords: Dynamic Equilibrium Economies; Stochastic Volatility; Asymmetric Impulse Responses; Perturbation

JEL Classification: C63, C68, E37

Suggested Citation

Diercks, Anthony M. and Hsu, Alex and Tamoni, Andrea, When It Rains It Pours: Cascading Uncertainty Shocks (July 26, 2019). Available at SSRN: https://ssrn.com/abstract=3427326 or http://dx.doi.org/10.2139/ssrn.3427326

Anthony M. Diercks

Board of Governors of the Federal Reserve System: Monetary and Financial Market Analysis ( email )

20th and C Streets, NW
Washington, DC 20551
United States

Alex Hsu (Contact Author)

Georgia Institute of Technology - Scheller College of Business ( email )

800 West Peachtree St.
Atlanta, GA 30308
United States
4043851123 (Phone)

Andrea Tamoni

Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick ( email )

1 Washington Park
Newark, NJ 07102
United States

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom
02079557303 (Phone)

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