Financial Distress and Endogenous Uncertainty

Francois Gourio

No 108, 2013 Meeting Papers from Society for Economic Dynamics

Abstract: A large amount of recent research in macroeconomics emphasizes the role of uncertainty as a driver of business cycles, but the majority of this work takes uncertainty as exogenous. This paper proposes a model where aggregate uncertainty is endogenously time-varying through financial distress costs. As firms become closer to default, their employment and investment demand is reduced by debt overhang. Moreover, firms' productivity may also be directly reduced by higher transaction costs. These two mechanisms make macroeconomic aggregates more volatile when a large number of firms have low equity value. The cross-sectional distribution of firms' equity values hence affects directly aggregate macroeconomic volatility. Empirical evidence consistent with the model is provided.

Date: 2013
New Economics Papers: this item is included in nep-dge and nep-mac
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Working Paper: Financial Distress and Endogenous Uncertainty (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed013:108

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