Uncertainty, Financial Frictions, and Investment Dynamics Simon Gilchrist, Jae W. Sim, and Egon Zakrajsek April 1, 2014 Abstract: Micro- and macro-level evidence shows that fluctuations in idiosyncratic uncertainty significantly affect investment, primarily through changes in credit spreads. Innovations in credit spreads strongly influence investment, regardless of uncertainty levels. These findings suggest that financial frictions, not just the traditional "wait-and-see" effect, drive macroeconomic outcomes from uncertainty. A quantitative general equilibrium model with heterogeneous firms, time-varying uncertainty, irreversibility, nonconvex capital adjustment costs, and financial frictions replicates macroeconomic implications of uncertainty and financial shocks. The model shows that both types of shocks significantly affect investment and generate countercyclical credit spreads and procyclical leverage, consistent with data. Financial frictions amplify the response of investment to volatility shocks, while the "wait-and-see" effect is less significant. The paper also identifies a new source of aggregate disturbances: capital liquidity shocks. These shocks can be important in economies with financial frictions. Empirical evidence shows that idiosyncratic volatility is a key determinant of credit spreads, and that uncertainty affects investment primarily through credit spreads. Capital expenditures remain highly responsive to credit spreads. A structural vector autoregression (SVAR) analysis confirms that credit spreads are a key channel through which volatility affects the real economy. Financial disturbances have a large effect on economic activity, regardless of uncertainty levels. The model's simulations align with empirical results, showing that financial frictions significantly amplify the response of investment to volatility shocks. The paper also highlights the importance of financial market frictions in explaining the countercyclical nature of credit spreads and the role of uncertainty in shaping business cycle dynamics. The findings support the notion that financial frictions are a crucial part of the mechanism through which uncertainty shocks affect the economy.Uncertainty, Financial Frictions, and Investment Dynamics Simon Gilchrist, Jae W. Sim, and Egon Zakrajsek April 1, 2014 Abstract: Micro- and macro-level evidence shows that fluctuations in idiosyncratic uncertainty significantly affect investment, primarily through changes in credit spreads. Innovations in credit spreads strongly influence investment, regardless of uncertainty levels. These findings suggest that financial frictions, not just the traditional "wait-and-see" effect, drive macroeconomic outcomes from uncertainty. A quantitative general equilibrium model with heterogeneous firms, time-varying uncertainty, irreversibility, nonconvex capital adjustment costs, and financial frictions replicates macroeconomic implications of uncertainty and financial shocks. The model shows that both types of shocks significantly affect investment and generate countercyclical credit spreads and procyclical leverage, consistent with data. Financial frictions amplify the response of investment to volatility shocks, while the "wait-and-see" effect is less significant. The paper also identifies a new source of aggregate disturbances: capital liquidity shocks. These shocks can be important in economies with financial frictions. Empirical evidence shows that idiosyncratic volatility is a key determinant of credit spreads, and that uncertainty affects investment primarily through credit spreads. Capital expenditures remain highly responsive to credit spreads. A structural vector autoregression (SVAR) analysis confirms that credit spreads are a key channel through which volatility affects the real economy. Financial disturbances have a large effect on economic activity, regardless of uncertainty levels. The model's simulations align with empirical results, showing that financial frictions significantly amplify the response of investment to volatility shocks. The paper also highlights the importance of financial market frictions in explaining the countercyclical nature of credit spreads and the role of uncertainty in shaping business cycle dynamics. The findings support the notion that financial frictions are a crucial part of the mechanism through which uncertainty shocks affect the economy.