Firm Risk and Leverage-Based Business Cycles

Sanjay Chugh

Review of Economic Dynamics, 2016, vol. 20, 111-131

Abstract: I characterize cyclical fluctuations in the cross-sectional dispersion of firm-level productivity. Using the micro-estimated dispersion, or "risk," stochastic process as an input to a baseline small-scale financial accelerator model, I assess how well the model reproduces cyclical movements in both real and financial conditions of the economy. In the model, risk shocks calibrated to micro data lead to empirically-relevant steady-state leverage, a financial measure typically thought to be closely associated with real activity. In terms of aggregate quantities, pure risk shocks in the small-scale general equilibrium model account for a notable share of GDP fluctuations -- roughly 5%. The volatility of the risk process I measure using micro data is, remarkably, not very different compared to recent estimates of risk shocks based on medium- or large-scale models using macroeconomic data. These seemingly contrasting starting points for measuring risk shocks do not imply any dichotomy at the core of a popular class of DSGE financial frictions models. Rather, it is the particular transmission channels in financial-frictions models -- whether small scale or medium scale -- that are critical for aggregate quantity fluctuations to arise based on risk shocks. (Copyright: Elsevier)

Keywords: Second-moment shocks; Time-varying volatility; Credit frictions; Financial accelerator (search for similar items in EconPapers)
JEL-codes: E10 E20 E32 E44 (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (32)

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DOI: 10.1016/j.red.2016.02.001

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