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Uncertainty Shocks, Asset Supply and Pricing over the Business Cycle

Francesco Bianchi, Cosmin Ilut and Martin Schneider

Review of Economic Studies, 2018, vol. 85, issue 2, 810-854

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.

Keywords: Uncertainty; Ambiguity; Investment; Excess volatility; Capital structure; Regime switches (search for similar items in EconPapers)
JEL-codes: E22 E32 E44 C11 D81 (search for similar items in EconPapers)
Date: 2018
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Related works:
Working Paper: Uncertainty shocks, asset supply and pricing over the business cycle (2017) Downloads
Working Paper: Uncertainty Shocks, Asset Supply and Pricing over the Business Cycle (2014) Downloads
Working Paper: Uncertainty Shocks, Asset Supply and Pricing over the Business Cycle (2013)
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