Uncertainty across volatility regimes

Abstract

Summary We propose a nonrecursive identification scheme for uncertainty shocks that exploits breaks in the volatility of macroeconomic variables and is novel in the literature on uncertainty. This approach allows us to simultaneously address two major questions in the empirical literature: Is uncertainty a cause or effect of decline in economic activity? Does the relationship between uncertainty and economic activity change across macroeconomic regimes? Results based on a small‐scale vector autoregression with US monthly data suggest that (i) uncertainty is an exogenous source of decline of economic activity, and (ii) the effects of uncertainty shocks amplify in periods of economic and financial turmoil.

Yield Curve and Financial Uncertainty: Evidence Based on US Data

“…Lütkepohl and Milunovich () and Casarin et al () confirm this finding. Angelini et al () do not reject the hypothesis that both financial and macroeconomic uncertainty are drivers of the business cycle (for similar results, see Angelini and Fanelli ) . We see the relationship between the financial side of uncertainty and the term structure of interest rates as a natural one.…”

Risk management-driven policy rate gap

“…2 First, Angelini, Bacchiocchi, Caggiano, and Fanelli (2017) and Ludvigson, Ma, and Ng (2018) …nd that …nancial uncertainty shocks -as opposed to macroeconomic uncertainty disturbances -are drivers of the business cycle. Second, and related to the previous point, several papers have recently documented the contribution of …nancial uncertainty shocks to the US business cycle (Bloom (2009), Caggiano, Castelnuovo, andGroshenny (2014), Leduc and Liu (2016), Basu and Bundick (2017), Caggiano, Castelnuovo, and Nodari (2017), Caggiano, Castelnuovo, and Pellegrino (2017)).…”

Exogenous uncertainty and the identification of structural vector autoregressions with external instruments

“…Right side: ex post correlations between the structural shockŝ t ∶= (̂a t ,̂F t ,̂M t ) ′ and the reduced-form shockŝZ 1 and̂Z 2 (relevance and orthogonality). Angelini et al (2019), who investigate the endogeneity/exogeneity of uncertainty by exploiting the breaks in unconditional volatility of a VAR for Y t :=(a t , U F,t , U M,t ) ′ across three main macroeconomic regimes of the US business cycle. Given the two external instruments Z t ∶= (Z 1,t , Z 2,t ) ′ = (Δhouse t , oil t ) ′ and driven by some preliminary evidence, we impose a diagonal structure on the covariance matrix of measurement errors Σ ; that is, we set 2,1 = 0 in Equation (17).…”

“…We consider a version of the index U M,t "purged" from possible effects of financial variables; seeAngelini et al (2019) for details.18 Interestingly,Pellegrino (2017) compares the real effects of a monetary shock in tranquil and turbulent periods by distinguishing the cases of endogenous and exogenous uncertainty. He reports that the responses of real variables to a monetary policy shock are halved when uncertainty is treated as an endogenous variable.19 We prefer not to consider explicitly a monetary policy shock among the list of candidate external instruments for the real economic activity shock.…”