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This paper compares macroeconomic effects of Knightian uncertainty and risk using policy shocks for the case of Italy. Drawing on the ambiguity literature I use changes in the bid-ask spread and mid-price of government bonds as distinct measures for uncertainty and risk. The identification exploits the quasi-pessimistic behavior under ambiguity-aversion and the dealer market structure of government bond markets where dealers must quote both sides of the market. If uncertainty increases ambiguity-averse dealers will quasi-pessimistically quote higher ask and lower bid prices - increasing the bid-ask spread. In contrast a pure change in risk shifts the risk-compensating discount factor which is well approximated by the change in bond mid-prices. I evaluate economic effects of the two measures within an instrumental variable local projection framework. The main findings are threefold. First the resulting shock time series for uncertainty and risk are uncorrelated with each other at the intraday level however upon aggre- gation to monthly level the measures become correlated. Second uncertainty is an important driver of economic aggregates. Third macroeconomic effects of risk and uncertainty are similar except for the response of prices. While sovereign risk raises inflation uncertainty suppresses price growth - a result which is in line with increased price rigidity under ambiguity. |
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