Three essays in price setting and volatility

This dissertation is composed of three essays examining the impact of time varying volatility on firm decision making. The first essay examines the effect of oil price volatility on price setting behavior using Producer Price Index micro data. I analyze whether two measures of price flexibility, price change frequency and dispersion, are affected by changes in oil price volatility. Heterogeneity in oil usage across industries is used to construct industry specific measures of oil price volatility. I find that price changes are more dispersed in high oil usage industries during months with high oil price volatility, however frequency of price change does not change. These results imply that aggregate price level flexibility does not fall during periods of high aggregate volatility. The second essay constructs a state-dependent pricing model with time varying oil price volatility to study if changes in aggregate volatility alter the impulse response of output to monetary policy. Firms use oil as an input to production, while oil price and oil price volatility processes are exogenous. Random menu costs enable the model to match the positive empirical relationship between oil price volatility and price change dispersion. A model simulation examines a counterfactual period of high oil price volatility and implies that increases in aggregate volatility do not substantially reduce the ability of monetary policy to stimulate output. The third essay examines the impact of time varying idiosyncratic uncertainty on investment with multiple types of capital. A model with two types of capital, short-lived equipment and long-lived structures, and nonconvex adjustment costs is constructed to examine the role of economies of scope on investment purchases. Evidence from a structural vector autoregression shows that investment in structures falls four quarters after an uncertainty shock, while investment in equipment falls within one quarter. The model with economies of scope in investment purchases is consistent with these results