News and Financial Intermediation in Aggregate and Sectoral Fluctuations

By Christoph Görtz and John Tsoukalas

We estimate a two-sector DSGE model with financial intermediaries – a-la Gertler and Karadi (2011) and Gertler and Kiyotaki (2010) – and quantify the importance of news shocks in accounting for aggregate and sectoral fluctuations. Our results indicate a significant role of financial market news as a predictive force behind fluctuations. Specifically, news about the value of assets held by financial intermediaries, reflected one to two years in advance in corporate bond markets, generate countercyclical corporate bonds spreads, affect the supply of credit, and are estimated to be a significant source of aggregate fluctuations, accounting for approximately 31% of output, 22% of investment and 31% of hours worked variation in cyclical frequencies. Importantly, asset value news shocks generate both aggregate and sectoral co-movement with a standard preference specification. Financial intermediation is key for importance and propagation of asset value news shocks.

Another paper that tries to introduces news shocks into some form of a standard model. The interesting aspect here is the quantification. Yet, I have the feeling that what is called news here may incorporate a lot more. For example, when there is herd behavior that drives assets prices one way or another, that is likely picked up as a news shock. Is that right? Or are news shocks capturing something that the econometrician does not observe, but market participants do, and it may even be a realized fundamental. Maybe I am just confused by a long day (see the RePEc blog tomorrow why).

One Response to News and Financial Intermediation in Aggregate and Sectoral Fluctuations

  1. John Tsoukalas says:

    Christian, thanks for the post. I will tend to agree with you that news may be also capturing factors that are absent from the model. I think this will be true in all models where news shocks is represented by a latent process. To what extend do ‘news’ shocks represent fundamentals vs. noise? I think this is the most challenging and fundamental question in this literature that, as far as I know, no one has been able to tackle yet.
    Our goal in the paper is to investigate if there is ‘news’ that can withstand the stricter test of sectoral co movement (in addition to broad based comovement) while at the same time not requiring GHH preferences, in other words, having KPR type preferences (I.e. with a non zero wealth effect on labor supply). One thing that comes out of this exercise is that financial prices are key in finding a significant role for news: the shock has very strong implications for bond spreads and equity that beats all the others in that dimension in the horserace.

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