Equilibrium Default and the Unemployment Accelerator

Gaston Navarro and Julio Blanco
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Julio Blanco: University of Michigan

No 1502, 2016 Meeting Papers from Society for Economic Dynamics

Abstract: We provide evidence of a significant and persistent negative relation between a firm's workers and her probability to default. In contrast with most "macro-finance" models, this relation is robust to controlling for the several firm's variables, such as the firm's leverage and profitability. In particular, for a panel of most US publicly traded firms, we find that a 10% increase in a firm's workers is associated with a 3% decline in her probability to default. To account for this fact, we extend a standard search-friction labor-market model to incorporate firms default risk. This environment provides a micro-foundation where workers determine the firm's value, and consequently affecting her incentives to default. We argue that fluctuations in the value of a worker generate and significantly amplify business cycle fluctuations. In the context of our model, we find that fluctuations in the value of a worker explain more than 68% of credit spreads volatility, and almost 80% of default rate volatility.

Date: 2016
New Economics Papers: this item is included in nep-bec, nep-dge and nep-mac
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Citations: View citations in EconPapers (3)

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