Time-Varying Expectation Effects of Switching Financial Uncertainty

This paper investigates the effects of dynamic capital market conditions in a general equilibrium model, employing a process of switching steady-state levels of the volatility of market conditions (SS-uncertainty). Decision-makers predict SS-uncertainty regimes using past fundamental shocks, but an exogenous uncertainty shock still exists. Model estimation un- covers evidence of state-dependent uncertainty effects. Shock responses significantly vary, depending on the current uncertainty regime and shock magnitude. In the high (low) SS-uncertainty regime, economic activities decrease (increase) regardless of shock direction. This anomaly disappears for sufficiently large uncertainty shocks. Quantitatively, a pessimistic shock produces inertia, whereas an optimistic shock boosts economic ac- activities