The Macroeconomic Effects of Uncertainty and Risk Aversion Shocks

Inspired by standard risk neutral measures of volatility, this paper identifies two types of volatility shocks, namely quantity and price of risk shocks, which can intuitively be interpreted as uncertainty and risk aversion shocks, respectively. Identification is achieved in a shock-restricted SVAR framework using a combination of narrative and external variable restrictions. We find that uncertainty shocks have large negative ef- fects on output, while risk aversion shocks are particularly damaging to asset prices and are deflationary. We also quantify to which extent risk aversion shocks can ex- acerbate the real effects of uncertainty shocks, thereby providing an estimate of the quantitative relevance of the risk-premium channel of uncertainty shocks. A historical contribution exercise suggests that the GFC is best characterized by a combination of uncertainty and risk aversion shocks, while uncertainty shocks were more important than risk aversion shocks during the COVID pandemic