Good and bad uncertainty: Macroeconomic and financial market implications

Abstract

Does macroeconomic uncertainty increase or decrease aggregate growth and asset prices? To address this question, we decompose aggregate uncertainty into 'good' and 'bad' volatility components, associated with positive and negative innovations to macroeconomic growth. We document that in line with our theoretical framework, these two uncertainties have opposite impact on aggregate growth and asset prices. Good uncertainty predicts an increase in future economic activity, such as consumption, output, and investment, and is positively related to valuation ratios, while bad uncertainty forecasts a decline in economic growth and depresses asset prices. Further, the market price of risk and equity beta of good uncertainty are positive, while negative for bad uncertainty. Hence, both uncertainty risks contribute positively to risk premia, and help explain the cross-section of expected returns beyond cash flow risk.

Good and Bad Variance Premia and Expected Returns

“…Expected consumption growth increases at times of good jump intensity and decreases when bad intensity is high. Segal, Shaliastovich, and Yaron (2015) provide direct empirical evidence for the feedback from macroeconomic volatilities on future real growth, consistent with this model assumption.…”

Good and Bad Variance Premia and Expected Returns

“…The probabilities of good and bad jumps vary over time and are driven by distinct processes. Our specification of consumption dynamics is related to Segal, Shaliastovich, and Yaron (2015) and Tsai and Wachter (2014), who also use Poisson jumps with separate intensities to isolate the variation in upward and downward moves in the fundamentals. It is also closely related to the good and bad environments specification of Bekaert and Engstrom (2009).…”

“…Segal, Shaliastovich, and Yaron (2015) study the implications of time variation in good and bad uncertainty, measured from macroeconomic data, for real growth and asset valuations. Bekaert and Engstrom (2009) consider a habit formation model with distinct variation in the volatilities of positive and negative Gamma shocks to fundamentals to address several stylized asset pricing puzzles, including the predictability of returns by the total variance premium.…”

A New Index of Uncertainty Based on Internet Searches: A Friend or Foe of Other Indicators?

“…As with the previous approach, a large variety of methods are employed: see Bachmann et al (2013), Jurado et al (2015), Rich and Tracy (2010), Rossi and Sekhposyan (2015), Scotti (2013), and Segal et al (2014).…”