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CEP discussion paper
The Impact of Uncertainty Shocks: Firm Level Estimation and a 9/11 Simulation
Nicholas Bloom
March 2006
Paper No' CEPDP0718:
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JEL Classification: D92; E22; D8; C23

Tags: labor; investment; uncertainty; real options

Uncertainty appears to vary strongly over time, temporarily rising by up to 200% around major shocks like the Cuban Missile crisis, the assassination of JFK and 9/11. This paper offers the first structural framework to analyze uncertainty shocks. I build a model with a time varying second moment, which is numerically solved and estimated using firm level data. The parameterized model is then used to simulate a macro uncertainty shock, which produces a rapid drop and rebound in employment, investment and productivity, and a moderate loss in GDP. This temporary impact of a second moment shock is different from the typically persistent impact of a first moment shock, highlighting the importance for policymakers of identifying their relative magnitudes in major shocks. The simulation of an uncertainty shock is then compared to actual 9/11 data, displaying a surprisingly good match.