When It Rains It Pours: Cascading Uncertainty Shocks

Abstract

The effects of uncertainty shocks are superadditive: the combination of nearby positive shocks is more powerful than the sum of their standalone effects. We document the superadditivity of uncertainty shocks via local projection and provide some narrative evidence about distinct uncertainty-inducing news events in close proximity to each other. 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.

Keywords: Dynamic Equilibrium Economies; Stochastic Volatility; Perturbation.

JEL Classification: C63, C68, E37