IDEAS home Printed from https://ideas.repec.org/a/eee/jmacro/v49y2016icp71-98.html
   My bibliography  Save this article

Uncertainty shocks in a model with mean-variance frontiers and endogenous technology choices

Author

Listed:
  • Mehkari, M. Saif

Abstract

This paper builds a model to show how increases in aggregate uncertainty – an uncertainty shock – can generate recessions. Uncertainty shocks in the model are able to both account for a significant portion of business cycle fluctuations observed in data and generate positive comovements between output, consumption, investment, and hours. The key assumption of the model is that firm managers endogenously choose what projects to undertake and that the menu of these projects lies on a positively sloped mean-variance frontier – high-return projects are also high-risk projects. In times of high aggregate uncertainty, managers choose to undertake low-risk projects, and thus low-return projects, which in turn leads to a recession. Moreover, the model also matches various stylized facts about time series and cross-sectional variations in TFP and suggests shortcomings in using TFP data to calculate exogenous TFP shocks.

Suggested Citation

  • Mehkari, M. Saif, 2016. "Uncertainty shocks in a model with mean-variance frontiers and endogenous technology choices," Journal of Macroeconomics, Elsevier, vol. 49(C), pages 71-98.
  • Handle: RePEc:eee:jmacro:v:49:y:2016:i:c:p:71-98
    DOI: 10.1016/j.jmacro.2016.05.001
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0164070416300180
    Download Restriction: Full text for ScienceDirect subscribers only

    File URL: https://libkey.io/10.1016/j.jmacro.2016.05.001?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. N. Bloom., 2016. "Fluctuations in uncertainty," VOPROSY ECONOMIKI, N.P. Redaktsiya zhurnala "Voprosy Economiki", vol. 4.
    2. Steven J. Davis & John Haltiwanger & Ron Jarmin & Javier Miranda, 2007. "Volatility and Dispersion in Business Growth Rates: Publicly Traded versus Privately Held Firms," NBER Chapters, in: NBER Macroeconomics Annual 2006, Volume 21, pages 107-180, National Bureau of Economic Research, Inc.
    3. Hansen, Gary D., 1985. "Indivisible labor and the business cycle," Journal of Monetary Economics, Elsevier, vol. 16(3), pages 309-327, November.
    4. Susanto Basu & Brent Bundick, 2017. "Uncertainty Shocks in a Model of Effective Demand," Econometrica, Econometric Society, vol. 85, pages 937-958, May.
    5. Nicholas Bloom & Max Floetotto & Nir Jaimovich & Itay Saporta†Eksten & Stephen J. Terry, 2018. "Really Uncertain Business Cycles," Econometrica, Econometric Society, vol. 86(3), pages 1031-1065, May.
    6. Jae Sim & Egon Zakrajsek & Simon Gilchrist, 2010. "Uncertainty, Financial Frictions, and Investment Dynamics," 2010 Meeting Papers 1285, Society for Economic Dynamics.
    7. Jesus Fernandez-Villaverde & Pablo Guerron-Quintana & Juan F. Rubio-Ramirez & Martin Uribe, 2011. "Risk Matters: The Real Effects of Volatility Shocks," American Economic Review, American Economic Association, vol. 101(6), pages 2530-2561, October.
    8. Luigi Guiso & Giuseppe Parigi, 1999. "Investment and Demand Uncertainty," The Quarterly Journal of Economics, Oxford University Press, vol. 114(1), pages 185-227.
    9. Ricardo Reis & Vasco Curdia, 2009. "Correlated Disturbances and U.S. Business Cycles," 2009 Meeting Papers 129, Society for Economic Dynamics.
    10. Jorg Dopke & Sebastian Weber, 2010. "The within-distribution business cycle dynamics of German firms," Applied Economics, Taylor & Francis Journals, vol. 42(29), pages 3789-3802.
    11. Benjamin Moll, 2014. "Productivity Losses from Financial Frictions: Can Self-Financing Undo Capital Misallocation?," American Economic Review, American Economic Association, vol. 104(10), pages 3186-3221, October.
    12. Fostel, Ana & Geanakoplos, John, 2012. "Why does bad news increase volatility and decrease leverage?," Journal of Economic Theory, Elsevier, vol. 147(2), pages 501-525.
    13. Nicholas Bloom, 2009. "The Impact of Uncertainty Shocks," Econometrica, Econometric Society, vol. 77(3), pages 623-685, May.
    14. King, Robert G. & Plosser, Charles I. & Rebelo, Sergio T., 1988. "Production, growth and business cycles : II. New directions," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 309-341.
    15. Tauchen, George, 1986. "Finite state markov-chain approximations to univariate and vector autoregressions," Economics Letters, Elsevier, vol. 20(2), pages 177-181.
    16. Rogerson, Richard, 1988. "Indivisible labor, lotteries and equilibrium," Journal of Monetary Economics, Elsevier, vol. 21(1), pages 3-16, January.
    17. Boris Nikolov & Toni M. Whited, 2014. "Agency Conflicts and Cash: Estimates from a Dynamic Model," Journal of Finance, American Finance Association, vol. 69(5), pages 1883-1921, October.
    18. Larry G. Epstein & Stanley E. Zin, 2013. "Substitution, risk aversion and the temporal behavior of consumption and asset returns: A theoretical framework," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 12, pages 207-239, World Scientific Publishing Co. Pte. Ltd..
    19. Victor Dorofeenko & Gabriel S. Lee & Kevin D. Salyer, 2008. "Time‐Varying Uncertainty And The Credit Channel," Bulletin of Economic Research, Wiley Blackwell, vol. 60(4), pages 375-403, October.
    20. Ayşe İmrohoroğlu & Şelale Tüzel, 2014. "Firm-Level Productivity, Risk, and Return," Management Science, INFORMS, vol. 60(8), pages 2073-2090, August.
    21. Fatih Guvenen, 2009. "A Parsimonious Macroeconomic Model for Asset Pricing," Econometrica, Econometric Society, vol. 77(6), pages 1711-1750, November.
    22. Low, Angie, 2009. "Managerial risk-taking behavior and equity-based compensation," Journal of Financial Economics, Elsevier, vol. 92(3), pages 470-490, June.
    23. Van Nieuwerburgh, Stijn & Veldkamp, Laura, 2006. "Learning asymmetries in real business cycles," Journal of Monetary Economics, Elsevier, vol. 53(4), pages 753-772, May.
    24. Ryan A. Decker & Pablo N. D'Erasmo & Hernan Moscoso Boedo, 2016. "Market Exposure and Endogenous Firm Volatility over the Business Cycle," American Economic Journal: Macroeconomics, American Economic Association, vol. 8(1), pages 148-198, January.
    25. Ben S. Bernanke, 1983. "Irreversibility, Uncertainty, and Cyclical Investment," The Quarterly Journal of Economics, Oxford University Press, vol. 98(1), pages 85-106.
    26. Matthias Kehrig, 2011. "The Cyclicality of Productivity Dispersion," 2011 Meeting Papers 484, Society for Economic Dynamics.
    27. Lawrence J. Christiano & Roberto Motto & Massimo Rostagno, 2014. "Risk Shocks," American Economic Review, American Economic Association, vol. 104(1), pages 27-65, January.
    28. Stephen R. Bond & Jason G. Cummins, 2004. "Uncertainty and investment: an empirical investigation using data on analysts' profits forecasts," Finance and Economics Discussion Series 2004-20, Board of Governors of the Federal Reserve System (U.S.).
    29. King, Robert G. & Plosser, Charles I. & Rebelo, Sergio T., 1988. "Production, growth and business cycles : I. The basic neoclassical model," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 195-232.
    30. Francisco J. Buera & Joseph P. Kaboski & Yongseok Shin, 2011. "Finance and Development: A Tale of Two Sectors," American Economic Review, American Economic Association, vol. 101(5), pages 1964-2002, August.
    31. Döpke, Jörg & Funke, Michael & Holly, Sean & Weber, Sebastian, 2005. "The cross-sectional dynamics of German business cycles: a bird's eye view," Discussion Paper Series 1: Economic Studies 2005,23, Deutsche Bundesbank.
    32. R?diger Bachmann & Steffen Elstner & Eric R. Sims, 2013. "Uncertainty and Economic Activity: Evidence from Business Survey Data," American Economic Journal: Macroeconomics, American Economic Association, vol. 5(2), pages 217-249, April.
    33. Tian, Can, 2011. "Technology choice and endogenous productivity dispersion over the business cycles," MPRA Paper 34480, University Library of Munich, Germany, revised 02 Nov 2011.
    34. Stephen A. Ross, 2004. "Compensation, Incentives, and the Duality of Risk Aversion and Riskiness," Journal of Finance, American Finance Association, vol. 59(1), pages 207-225, February.
    35. Leduc, Sylvain & Liu, Zheng, 2016. "Uncertainty shocks are aggregate demand shocks," Journal of Monetary Economics, Elsevier, vol. 82(C), pages 20-35.
    36. Eisfeldt, Andrea L. & Rampini, Adriano A., 2006. "Capital reallocation and liquidity," Journal of Monetary Economics, Elsevier, vol. 53(3), pages 369-399, April.
    37. Graham, John R. & Harvey, Campbell R. & Puri, Manju, 2013. "Managerial attitudes and corporate actions," Journal of Financial Economics, Elsevier, vol. 109(1), pages 103-121.
    38. Hartman, Richard, 1972. "The effects of price and cost uncertainty on investment," Journal of Economic Theory, Elsevier, vol. 5(2), pages 258-266, October.
    39. Higson, C. & Holly, S. & Kattuman, P., 2002. "The cross-sectional dynamics of the US business cycle: 1950-1999," Journal of Economic Dynamics and Control, Elsevier, vol. 26(9-10), pages 1539-1555, August.
    40. Abel, Andrew B, 1983. "Optimal Investment under Uncertainty," American Economic Review, American Economic Association, vol. 73(1), pages 228-233, March.
    41. C. Higson & S. Holly & P. Kattuman & S. Platis, 2004. "The Business Cycle, Macroeconomic Shocks and the Cross-Section: The Growth of UK Quoted Companies," Economica, London School of Economics and Political Science, vol. 71(281), pages 299-318, May.
    42. Bachmann, Rüdiger & Bayer, Christian, 2013. "‘Wait-and-See’ business cycles?," Journal of Monetary Economics, Elsevier, vol. 60(6), pages 704-719.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Johannes Strobel & Binh Nguyen Thanh & Gabriel Lee, 2020. "Effects of Macroeconomic Uncertainty and Labor Demand Shocks on the Housing Market," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 48(2), pages 345-372, June.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. N. Bloom., 2016. "Fluctuations in uncertainty," VOPROSY ECONOMIKI, N.P. Redaktsiya zhurnala "Voprosy Economiki", vol. 4.
    2. Bachmann, Rüdiger & Bayer, Christian, 2013. "‘Wait-and-See’ business cycles?," Journal of Monetary Economics, Elsevier, vol. 60(6), pages 704-719.
    3. Bachmann, Rüdiger & Elstner, Steffen & Hristov, Atanas, 2017. "Surprise, surprise – Measuring firm-level investment innovations," Journal of Economic Dynamics and Control, Elsevier, vol. 83(C), pages 107-148.
    4. Jesus Fernandez-Villaverde & Pablo Guerron-Quintana, 2020. "Uncertainty Shocks and Business Cycle Research," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 37, pages 118-166, August.
    5. Nicholas Bloom & Fatih Guvenen & Sergio Salgado, 2016. "Skewed Business Cycles," 2016 Meeting Papers 1621, Society for Economic Dynamics.
    6. Bachmann, Rüdiger & Born, Benjamin & Elstner, Steffen & Grimme, Christian, 2019. "Time-varying business volatility and the price setting of firms," Journal of Monetary Economics, Elsevier, vol. 101(C), pages 82-99.
    7. Born, Benjamin & Pfeifer, Johannes, 2014. "Policy risk and the business cycle," Journal of Monetary Economics, Elsevier, vol. 68(C), pages 68-85.
    8. Tian, Can, 2015. "Riskiness, endogenous productivity dispersion and business cycles," Journal of Economic Dynamics and Control, Elsevier, vol. 57(C), pages 227-249.
    9. Basile, Roberto & Girardi, Alessandro, 2018. "Uncertainty and Business Cycle: A Review of the Literature and Some Evidence from the Spanish Economy/Incertidumbre y Ciclo Empresarial: Revisión de la literatura y evidencia en la economía española," Estudios de Economia Aplicada, Estudios de Economia Aplicada, vol. 36, pages 235-250, Enero.
    10. Kıvanç Karaman, K. & Yıldırım-Karaman, Seçil, 2019. "How does financial development alter the impact of uncertainty?," Journal of Banking & Finance, Elsevier, vol. 102(C), pages 33-42.
    11. Benhabib, Jess & Liu, Xuewen & Wang, Pengfei, 2016. "Endogenous information acquisition and countercyclical uncertainty," Journal of Economic Theory, Elsevier, vol. 165(C), pages 601-642.
    12. Straub, Ludwig & Ulbricht, Robert, 2019. "Endogenous second moments: A unified approach to fluctuations in risk, dispersion, and uncertainty," Journal of Economic Theory, Elsevier, vol. 183(C), pages 625-660.
    13. Nicholas Bloom & Max Floetotto & Nir Jaimovich & Itay Saporta†Eksten & Stephen J. Terry, 2018. "Really Uncertain Business Cycles," Econometrica, Econometric Society, vol. 86(3), pages 1031-1065, May.
    14. Gabriel P. Mathy, 2020. "How much did uncertainty shocks matter in the Great Depression?," Cliometrica, Springer;Cliometric Society (Association Francaise de Cliométrie), vol. 14(2), pages 283-323, May.
    15. Cosmin Ilut & Matthias Kehrig & Martin Schneider, 2018. "Slow to Hire, Quick to Fire: Employment Dynamics with Asymmetric Responses to News," Journal of Political Economy, University of Chicago Press, vol. 126(5), pages 2011-2071.
    16. Mecikovsky, Ariel & Meier, Matthias, 2014. "Do plants freeze upon uncertainty shocks?," EconStor Preprints 100662, ZBW - Leibniz Information Centre for Economics.
    17. Ruediger Bachmann & Christian Bayer, 2009. "Firm-Specific Productivity Risk over the Business Cycle: Facts and Aggregate Implications," 2009 Meeting Papers 869, Society for Economic Dynamics.
    18. Lee, Junghoon, 2016. "The impact of idiosyncratic uncertainty when investment opportunities are endogenous," Journal of Economic Dynamics and Control, Elsevier, vol. 65(C), pages 105-124.
    19. Bańbura, Marta & Albani, Maria & Ambrocio, Gene & Bursian, Dirk & Buss, Ginters & de Winter, Jasper & Gavura, Miroslav & Giordano, Claire & Júlio, Paulo & Le Roux, Julien & Lozej, Matija & Malthe-Thag, 2018. "Business investment in EU countries," Occasional Paper Series 215, European Central Bank.
    20. Laurent Ferrara & Stéphane Lhuissier & Fabien Tripier, 2018. "Uncertainty Fluctuations: Measures, Effects and Macroeconomic Policy Challenges," Financial and Monetary Policy Studies, in: Laurent Ferrara & Ignacio Hernando & Daniela Marconi (ed.), International Macroeconomics in the Wake of the Global Financial Crisis, pages 159-181, Springer.

    More about this item

    Keywords

    Business cycles; Uncertainty shocks;

    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:jmacro:v:49:y:2016:i:c:p:71-98. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: . General contact details of provider: http://www.elsevier.com/locate/inca/622617 .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/inca/622617 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.