The Impact of Uncertainty Shocks

Source: Bloom, N. (2009). Econometrica 77(3), 623–685.

TL;DR

Shows that spikes in uncertainty — measured by jumps in stock-market volatility (e.g. the VIX) around

events like the Cuban Missile Crisis, JFK's assassination, OPEC I, and 9/11 — cause sharp, short

drops and rebounds in investment, hiring, and output. Faced with more uncertainty, firms adopt a

"wait-and-see" posture (real-options effect), pausing irreversible investment and hiring until the fog

clears; activity then rebounds and overshoots.

A structural framework linking financial-market uncertainty (a second-moment shock) to real activity,

distinct from the well-studied first-moment (levels) shocks. Bloom builds a heterogeneous-firm model

with a time-varying second moment and a mix of convex and non-convex labor and capital adjustment

costs, solves it numerically, and estimates it on firm-level data via simulated method of moments.

Real options: when uncertainty is high, the option value of waiting rises, so firms freeze

irreversible investment and hiring; productivity growth also falls as reallocation across units freezes.

After the shock passes, pent-up demand drives a rebound and a medium-term overshoot in output,

employment, and productivity ("volatility overshoot").

Higher-order: uncertainty reduces the responsiveness of firms, dampening policy effectiveness.

Identifies 16 uncertainty shocks over ~46 years as volatility spikes >1.65 SD above the

HP-detrended mean (implied volatility rises by up to ~200%) — roughly one every three years.

A VAR shows industrial production falls ~1% within about four months then rebounds, with the

drop-and-rebound lasting roughly 6 months and an overshoot from month 7–8 onward; first-moment

(interest-rate / stock-level) shocks instead produce a slower drop-rebound lasting 2–3 years.

The calibrated structural model reproduces this drop-rebound-overshoot dynamic in both magnitude and

timing; ignoring capital adjustment costs biases estimates substantially, ignoring labor costs less so.

The foundational paper linking measured volatility/uncertainty to macro fluctuations; it established the

"second-moment shock" research program, motivated the EPU index (Baker-Bloom-Davis) and the

macro-uncertainty literature, and legitimized the VIX as a real-economy signal.

Volatility spikes conflate uncertainty with first-moment (bad-news) shocks; disentangling the two is

contested.

The real-options channel is one of several; financial-frictions channels also matter.

Bloom, N. (2009) — The Impact of Uncertainty Shocks — Econometrica

Baker, S., Bloom, N. & Davis, S. (2016) — Measuring Economic Policy Uncertainty — Quarterly Journal of Economics

Bloom, N. et al. (2018) — Really Uncertain Business Cycles — Econometrica

Provenance: verified/generated from the paper's full text.