NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Uncertainty Shocks, Asset Supply and Pricing over the Business Cycle

Francesco Bianchi, Cosmin L. Ilut, Martin Schneider

NBER Working Paper No. 20081
Issued in May 2014
NBER Program(s):   AP   CF   EFG   ME

This paper 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 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.

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This paper was revised on March 29, 2017

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Document Object Identifier (DOI): 10.3386/w20081

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