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

Bijapur, Mohan (2014): What Drives Business Cycle Fluctuations: Aggregate or Idiosyncratic Uncertainty Shocks?

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.

• Item Type: MPRA Paper
• Language: English
• Keywords: Idiosyncratic uncertainty shocks; aggregate uncertainty shocks; business cycles; Granular origins.
• Subjects: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations ; Cycles

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