Essays on Impacts of Economic Uncertainty


Student thesis: Doctoral Thesis

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Award date10 Sep 2019


There has been a renewed interest in studying economic uncertainty and its consequences since the last global financial crisis. The literature documents that, after major economic, financial, and even political shocks, uncertainty increased dramatically and, in turn, sparked further economic turmoil. This thesis contains two essays that extend the literature by providing empirical evidence on the effect of uncertainty shocks on the financial market as well as on the real economy.

The first essay examines the portfolio adjustment of global mutual funds to uncertainty shocks. It draws first on the literature related to measuring uncertainty with financial market proxies. The essential work of Bloom (2009) empirically establishes the stock market volatility as a measure of macroeconomic uncertainty. More specifically, the authors use the realized volatility series of U.S. stock market for their purpose. The first essay expands this approach and creates a global measure of uncertainty based on data from multiple financial markets.
The essay also draws on more recent developments in the literature and uses a factor model to extract the global uncertainty shared by financial markets of both developed countries and emerging markets. Alongside the common factor, the framework also allows us to identify idiosyncratic uncertainty factors in each country. Finally, we combine the uncertainty measures, both common and idiosyncratic, with a dataset of global mutual fund portfolio allocations and investigate the portfolio adjustment regarding uncertain outlooks. The empirical strategy to study the portfolio evolution follows the methodology of Raddatz and Schmukler (2012). We show that global uncertainty is relevant for the portfolio decisions of global bond funds and equity funds. The mutual funds adjust their holdings asymmetrically in the face of uncertainty. The global financial crisis has also amplified the fund managers’ discrimination among countries.

The second essay represents a factor-augmented vector autoregression study of the impact of uncertainty on the real economy. First, this essay distinguishes uncertainty from different sources, more specifically, macroeconomic and financial uncertainty, based on a panel of U.S. macroeconomic and financial variables. Shocks to the two sets of variables follow a volatility process governed by a factor structure. We define uncertainty to be the innovation of this volatility process, and the estimation of both the macroeconomic and financial uncertainty correlates with other popular proxies in the literature. However, the two measures have low tendency to comove. Macroeconomic uncertainty increased during the global crises, whereas financial uncertainty spiked in several phases of financial market turmoil. Second, this essay estimates the impulse responses of aggregate variables and state-level real income to the uncertainty shocks. At the aggregate level, one standard deviation of macroeconomic uncertainty generates a more significant contractionary response in the real economy. The response to financial uncertainty is not as noticeable. At the state-level, financial friction and industrial structure lead to dissimilar responses to the shocks. The heterogeneity points to the different transmission mechanisms of the uncertainty shocks.