This paper investigates how financial conditions and macroeconomic uncertainty jointly affect macroeconomic tail risks. We first document that tight financial conditions decrease all conditional quantiles of future output growth in the near term, while high macroeconomic uncertainty stretches the interquartile range, leaving the median intact. Because financial conditions and uncertainty comove substantially, the conditional means and variances shift simultaneously in the opposite direction. Consequently, the downside risk varies much more than the upside risk. Using a structural VAR, we find that both financial and uncertainty shocks tighten financial conditions and heighten macroeconomic uncertainty instantaneously. Therefore, all conditional quantiles of output growth decrease disproportionately in response to both shocks, and the conditional distribution of output growth not only shifts but also skews to the left, leading to greater growth vulnerability for 2 to 3 years in the future.
Macroeconomic turbulence and volatility in financial markets can fatally affect firm's performance. Very few firms make serious attempts to inform market participants and other outsider stakeholders about the impact of macroeconomic fluctuations--manifested as changes in exchange rates, interest rates, inflation rates and stock market returns-- on performance. These stakeholders, as well as financial analysts, must make their own assessments but they generally lack both the required tools and the information to do so. Worse, top management in most firms do not themselves possess the tools to identify whether a change in performance represents a change in the firm's intrinsic competitiveness or a reflection of macroeconomic conditions outside their influence. Corporate Decision-Making with Macroeconomic Uncertainty: Performance and Risk Management develops and presents in an easily comprehensible way the essential elements of a corporate strategy for managing uncertainty in the macroeconomic environment. This Macroeconomic Uncertainty Strategy, or MUST, enhances firm value by allowing management and external stakeholders to become better informed about the development of corporate competitiveness in a turbulent macroeconomic environment. The MUST also provides guidelines for how to develop a successful risk management program. This research based book includes methods to identify the impact of macroeconomic fluctuations on cash flows and value, to develop strategies for macroeconomic risk management, to provide informative reports to external stakeholders, to evaluate the relative performance of subsidiaries and business units in multinational companies, and to evaluate performance for purposes of setting executive compensation and of fulfilling the due diligence requirements in an M & A context. The authors' use of value-based management, various performance measurements, the concept of real options, and risk management from the perspective of shareholder wealth maximization, makes the book rich and compelling. They address researchers and students in the field of international business, finance and corporate governance. On the business side, executives with strategic responsibilities, chief financial officers, and bankers who analyze corporate performance and give advice on risk management will benefit from reading this book.
Macroeconomic Uncertainty International Risks and Opportunities for the Corporation L. Oxelheim, Scandinavian Institute for Foreign Exchange Research and C. Wihlborg, University of Southern California, Los Angeles All corporate bodies are exposed to economic risks over which they have little or no control. Studies of macroeconomics have highlighted areas which threaten corporations, but until now no book has developed a comprehensive and consistent approach for managers faced with the problems of measuring and managing risks. In Macroeconomic Uncertainty, fluctuations in exchange rates, inflation rates, interest rates, relative prices among commodities as well as changes in different markets’ ‘rules of the game’ are analysed in terms of how they may affect a company’s profitability. Disturbances which may result from monetary or fiscal policy shifts, or from non-policy factors, are evaluated. Both domestic and international macroeconomic disturbances are approached with a view to developing a management strategy consistent with shareholders’ objectives to implement a successful programme by identifying an adequate trade-off between risks and opportunities. This highly readable book will provide senior managers and executives with a method for arriving at a strategy to deal effectively with macroeconomic uncertainty.
This paper presents a simple heuristic measure of tail risk, which is applied to individual bank stress tests and to public debt. Stress testing can be seen as a first order test of the level of potential negative outcomes in response to tail shocks. However, the results of stress testing can be misleading in the presence of model error and the uncertainty attending parameters and their estimation. The heuristic can be seen as a second order stress test to detect nonlinearities in the tails that can lead to fragility, i.e., provide additional information on the robustness of stress tests. It also shows how the measure can be used to assess the robustness of public debt forecasts, an important issue in many countries. The heuristic measure outlined here can be used in a variety of situations to ascertain an ordinal ranking of fragility to tail risks.
Are empirical measures of uncertainty informative about risks to future economic activity? I use quantile regression analysis and density predictions on United States data to show that the relationship between macroeconomic uncertainty and future GDP growth is nonlinear and asymmtric. The left tail of the distribution of future GDP growth is highly responsive to fluctuations in macroeconomic uncertainty, whereas the right tail is relatively stable. As such, macroeconomic uncertainty predicts downside risks to growth but is less informative about upside risks. When combined with an index of financial conditions - a previously proposed predictor of downside risks to growth - macroeconomic uncertainty carries a larger weight in the optimal predictive density. Finally, I provide evidence that alternative empirical measures of uncertainty, such as economic policy uncertainty and geopolitical risk, do not predict risks to the economic outlook. These results hold for a larger sample of countries and underline the importance of differentiating between measures of uncertainty when predicting risks to growth.
I document that dividend growth and returns on the aggregate U.S. stock market are more correlated with consumption growth in bad economic times. In a consumption-based asset pricing model with a generalized disappointment averse investor and small, IID consumption shocks, this feature results in a realistic equity premium despite low risk aversion. The model is consistent with the main facts about stock market risk premia inferred from equity index options, remains tightly parameterized, and allows for analytical solutions for asset prices. An extension with non-IID dynamics accounts for excess volatility and return predictability while preserving the model's consistency with option moments.
