Three essays on uncertainty: real and financial effects of uncertainty shocks

The thesis consists of three essays on real and financial effects of uncertainty shocks. The first chapter investigates two different news-based uncertainty indices, Economic Policy Uncertainty Index (EPU) and Relative Sentiment Shift Index (RSS). I employ reduced form VAR and local projections (Jordá, 2005) to explore the differences in wait-and-see effect of uncertainty on the real economy. Surprises in either index lead to significant declines in production and employment and the effect is larger and persistent in the case of RSS shocks than EPU. In the second chapter, the probabilistic approach is applied to uncover the dependence structure in inflation uncertainty for the countries bordering a major currency area, the UK and the euro area. Inflation uncertainty is measured by the conditional volatility removing entire forecastable variations by bivariate VAR GARCH model and joint distribution of uncertainties of two regions is estimated by using copula to account for non-linear association. The results show that the left tail events of inflation are positively correlated between the two regions. This implies that the appropriate monetary policy can be drawn if policymakers consider the interconnectedness of the deflationary pressures. Finally, the third chapter examines the long run relationship between gross capital flow and its determinants, focusing on the impact of uncertainty as global and contagion factors. I apply bounds testing approach by Pesaran, Shin, and Smith (2001) allowing for he underlying regressors being either I(0), I(1) or mutually cointegrated. Both gross capital inflows and outflows exhibit significant level relationship with global, contagion and domestic factors and uncertainty spillovers through financial linkages between the UK and the euro area play crucial role in predicting capital flows of the UK.