Understanding uncertainty shocks and the role of black swans

Anna Orlik and Laura Veldkamp

Journal of Economic Theory, 2024, vol. 222, issue C

Abstract: Uncertainty shocks can trigger business cycles, bank runs and asset price fluctuations. But how do those shocks translate into changes in beliefs and actions? What makes people suddenly become uncertain? This paper provides an explanation for subjective uncertainty shocks, estimated on real-time GDP data, that fits puzzling features of professional forecasts. The key ingredients are that agents do not know the true model governing the distribution of macroeconomic outcomes, but they believe that distribution to be potentially skewed. When agents estimate higher probabilities of extreme tail events, their uncertainty rises. Our estimates reveal that learning about probabilities of tail events – black swans – explains much of the fluctuations in subjective uncertainty.

Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jetheo:v:222:y:2024:i:c:s002205312400111x

DOI: 10.1016/j.jet.2024.105905

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