A New Look at Uncertainty Shocks: Imperfect Information and Misallocation

Tatsuro Senga | Queen Mary University, London

Uncertainty faced by individual firms appears to be heterogeneous. In this paper, I construct a new set of empirical measures of firm-level uncertainty using data such as the IBES and Compustat. The panel data that I construct reveals persistent differences in the degree of uncertainty facing individual firms not reflected by existing measures.  Consistent with existing measures, I find that the average level of uncertainty across firms is countercyclical, and that it rose sharply at the start of the Great Recession. I next develop a heterogeneous firm model in a setting wherein each firm gradually learns about its own productivity, and each occasionally experiences a shock forcing it to start learning afresh. Uncertainty will be resolved gradually as firms operate longer and get better informed. When calibrated to reproduce the level and cyclicality of the measure of firm-level uncertainty, I show that an uncertainty shock explains 28 percent of the observed decline in GDP and 31 percent of the fall in investment during the Great Recession.