Abstract: 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 narrative restrictions. We find that uncertainty shocks have large negative effects 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 exacerbate the real effects of uncertainty shocks, thereby providing an estimate of the quantitative relevance of the risk-premium channel of uncertainty shocks. Our results suggest that both uncertainty and risk aversion shocks were important drivers of the Great Financial Crisis. For the COVID recession, uncertainty shocks were the main drivers while risk aversion played a more limited role.
Published: European Economic Review, Volume 153, May 2023, 10442