Credit Market Frictions and the Linkage Between Dispersion and Macro Uncertainty

Jun E. Li ()
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Jun E. Li: Warwick Business School, University of Warwick, Coventry CV4 7AL, United Kingdom

Management Science, 2025, vol. 71, issue 6, 5288-5307

Abstract: Cross-sectional dispersion and macro uncertainty (volatility of aggregate economic variables) are conceptually distinct. However, empirically, they both comove and are countercyclical. This paper builds a general equilibrium model and demonstrates that credit market frictions allow cross-sectional dispersion to drive time-varying macro uncertainty endogenously. In the model, as firm-level productivity becomes more dispersed, more firms are pushed to the left tail of the productivity distribution, resulting in more defaults and a depletion in aggregate net worth. This mechanism generates countercyclical leverage and aggregate volatility. The model implies that the government can inject equity in economic downturns to stabilize aggregate volatility.

Keywords: uncertainty; financial frictions; asset prices (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:71:y:2025:i:6:p:5288-5307

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