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The Finance Uncertainty Multiplier

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  • Iván Alfaro
  • Nicholas Bloom
  • Xiaoji Lin

Abstract

We show how real and financial frictions amplify the impact of uncertainty shocks. We build a model with real frictions, and find adding financial frictions roughly doubles the impact of uncertainty shocks. Higher uncertainty alongside financial frictions induces the standard real-options effects on investment and hiring, but also leads firms to hoard cash, further reducing investment and hiring. We then test the model using a panel of US firms and a novel instrumentation strategy for uncertainty exploiting differential firm exposure to exchange rate and price volatility. These results highlight why in periods with greater financial frictions uncertainty can be particularly damaging.

Suggested Citation

  • Iván Alfaro & Nicholas Bloom & Xiaoji Lin, 2018. "The Finance Uncertainty Multiplier," NBER Working Papers 24571, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:24571
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    • E0 - Macroeconomics and Monetary Economics - - General
    • G0 - Financial Economics - - General

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