Time-varying ambiguity shocks and business cycles

Abstract

This study investigates how ambiguity has driven output and inflation in the U.S. over the past 70 years. We adopt the recently developed techniques that disentangle ambiguity from risk and assess the responses of output and inflation to ambiguity shocks. We observe that an increase in ambiguity led to an increase in output during high inflation periods, indicating the ambiguity lover behavior. We also uncover that ambiguity and risk estimated by realized volatility have the opposite impacts on business cycles, which is consistent with the prevailing asset pricing literature.