Uncertainty Shocks, Asset Supply and Pricing over the Business Cycle
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.
We would like to thank Nick Bloom, Joao Gomes, Francois Gourio, Bob Hall, Lars Hansen, Nir Jaimovich, Konstantinos Theodoridis, Nic Vincent and Amir Yaron as well as workshop and conference participants at AEA, Boston Fed, Chicago Fed, Cornell, CREI, Duke, LBS, LSE, Mannheim, Minneapolis Fed, NBER Summer Institute, NYU, Queen's, Philadelphia Fed, Reserve Bank of Australia, SED, SITE, University of Chicago, UCSD and UT Austin for helpful discussions and comments. Cosmin Ilut gratefully acknowledges financial support from the NSF through grant SES-3331805. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Francesco Bianchi & Cosmin L. Ilut & Martin Schneider, 2018. "Uncertainty Shocks, Asset Supply and Pricing over the Business Cycle," The Review of Economic Studies, vol 85(2), pages 810-854. citation courtesy of