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Uncertainty Shocks, Asset Supply and Pricing over the Business Cycle

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  • Francesco Bianchi
  • Cosmin L. Ilut
  • Martin Schneider

Abstract

This article estimates a business cycle model with endogenous financial asset supply and ambiguity averse investors. Firms’ shareholders choose not only production and investment, but also capital structure and payout policy subject to financial frictions. An increase in uncertainty about profits lowers stock prices and leads firms to substitute away from debt as well as reduce shareholder payout. This mechanism parsimoniously accounts for the postwar comovement in investment, stock prices, leverage, and payout, at both business cycle and medium term cycle frequencies. Ambiguity aversion permits a Markov-switching VAR representation of the model, while preserving the effect of uncertainty shocks on the time variation in the equity premium.

Suggested Citation

  • Francesco Bianchi & Cosmin L. Ilut & Martin Schneider, 2018. "Uncertainty Shocks, Asset Supply and Pricing over the Business Cycle," Review of Economic Studies, Oxford University Press, vol. 85(2), pages 810-854.
  • Handle: RePEc:oup:restud:v:85:y:2018:i:2:p:810-854.
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    File URL: http://hdl.handle.net/10.1093/restud/rdx035
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    Cited by:

    1. Eran Hoffmann, 2018. "The Cyclical Composition of Startups," 2018 Meeting Papers 553, Society for Economic Dynamics.
    2. Saijo, Hikaru, 2017. "The uncertainty multiplier and business cycles," Journal of Economic Dynamics and Control, Elsevier, vol. 78(C), pages 1-25.
    3. Jun Gao & Sheng Zhu & Niall O’Sullivan & Meadhbh Sherman, 2019. "The Role of Economic Uncertainty in UK Stock Returns," Journal of Risk and Financial Management, MDPI, Open Access Journal, vol. 12(1), pages 1-16, January.
    4. Drobetz, Wolfgang & El Ghoul, Sadok & Guedhami, Omrane & Janzen, Malte, 2018. "Policy uncertainty, investment, and the cost of capital," Journal of Financial Stability, Elsevier, vol. 39(C), pages 28-45.
    5. Bianchi, Francesco & Melosi, Leonardo, 2019. "The dire effects of the lack of monetary and fiscal coordination," Journal of Monetary Economics, Elsevier, vol. 104(C), pages 1-22.
    6. Kozeniauskas, Nicholas & Orlik, Anna & Veldkamp, Laura, 2018. "What are uncertainty shocks?," Journal of Monetary Economics, Elsevier, vol. 100(C), pages 1-15.
    7. Yu, Edison G., 2018. "Dynamic market participation and endogenous information aggregation," Journal of Economic Theory, Elsevier, vol. 175(C), pages 491-517.
    8. Dew-Becker, Ian & Nathanson, Charles G., 2019. "Directed attention and nonparametric learning," Journal of Economic Theory, Elsevier, vol. 181(C), pages 461-496.
    9. Hikaru Saijo, 2018. "Redistribution and Fiscal Uncertainty Shocks," IMES Discussion Paper Series 18-E-15, Institute for Monetary and Economic Studies, Bank of Japan.
    10. Francesco Bianchi & Howard Kung & Mikhail Tirskikh, 2019. "The Origins and Effects of Macroeconomic Uncertainty," 2019 Meeting Papers 245, Society for Economic Dynamics.
    11. Bianchi, Francesco & Kung, Howard & Tirskikh, Mikhail, 2019. "The Origins and Effects of Macroeconomic Uncertainty," CEPR Discussion Papers 13450, C.E.P.R. Discussion Papers.
    12. Anmol Bhandari & Jaroslav Borovicka & Paul Ho, 2019. "Survey Data and Subjective Beliefs in Business Cycle Models," Working Paper 19-14, Federal Reserve Bank of Richmond.
    13. Bali, Turan G. & Brown, Stephen J. & Tang, Yi, 2017. "Is economic uncertainty priced in the cross-section of stock returns?," Journal of Financial Economics, Elsevier, vol. 126(3), pages 471-489.
    14. Anmol Bhandari & Jaroslav Borovička & Paul Ho, 2016. "Identifying Ambiguity Shocks in Business Cycle Models Using Survey Data," NBER Working Papers 22225, National Bureau of Economic Research, Inc.
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    16. A. Ronald Gallant & Mohammad Jahan-Parvar & Hening Liu, 2015. "Measuring Ambiguity Aversion," Finance and Economics Discussion Series 2015-105, Board of Governors of the Federal Reserve System (U.S.), revised 23 Nov 2015.
    17. Francesco Bianchi & Howard Kung & Mikhail Tirskikh, 2018. "The Origins and Effects of Macroeconomic Uncertainty," NBER Working Papers 25386, National Bureau of Economic Research, Inc.
    18. Sydney C. Ludvigson & Sai Ma & Serena Ng, 2015. "Uncertainty and Business Cycles: Exogenous Impulse or Endogenous Response?," NBER Working Papers 21803, National Bureau of Economic Research, Inc.
    19. Diego Comin & Ana Maria Santacreu & Mark Gertler & Phuong Ngo, 2018. "Stock Price Fluctuations and Productivity Growth," 2018 Meeting Papers 1147, Society for Economic Dynamics.

    More about this item

    Keywords

    Uncertainty; Ambiguity; Investment; Excess volatility; Capital structure; Regime switches;

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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