What Drives Business Cycle Fluctuations: Aggregate or Idiosyncratic Uncertainty Shocks?

Mohan Bijapur

MPRA Paper from University Library of Munich, Germany

Abstract: We study jointly the roles of aggregate and idiosyncratic uncertainty shocks in driving business cycle fluctuations. By decomposing total stock return volatility of over 20,000 publicly-listed US firms from 1962 to 2012, we construct separate indices for aggregate and idiosyncratic uncertainty, and run a horse race between them in an otherwise standard macroeconomic VAR. We find that idiosyncratic uncertainty shocks account for a large fraction of fluctuations in economic activity at business cycle frequencies, whereas the impacts of aggregate uncertainty are negligible. Idiosyncratic uncertainty, and not aggregate uncertainty, shocks produce the "sharp drop and rapid rebound" response in activity characterized in Bloom (2009). Idiosyncratic uncertainty shocks to large firms have more powerful macroeconomic impacts than small firms, suggesting "Granular" origins to the role of uncertainty in the macroeconomy. We also find evidence of an economy-wide "buffering effect", in which the effects of large and small firms’ shocks exhibit a negative covariance which dampens down the aggregate effects of idiosyncratic uncertainty shocks on economic fluctuations.

Keywords: Idiosyncratic uncertainty shocks; aggregate uncertainty shocks; business cycles; Granular origins. (search for similar items in EconPapers)
JEL-codes: E32 (search for similar items in EconPapers)
Date: 2014-11-01
New Economics Papers: this item is included in nep-bec and nep-mac
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Citations: View citations in EconPapers (2)

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