Financial frictions and fluctuations in volatility

Cristina Arellano, Yan Bai and Patrick Kehoe

No 466, Staff Report from Federal Reserve Bank of Minneapolis

Abstract: During the recent U.S. financial crisis, the large decline in economic activity and credit was accompanied by a large increase in the dispersion of growth rates across firms. However, even though aggregate labor and output fell sharply during this period, labor productivity did not. These features motivate us to build a model in which increased volatility at the firm level generates a downturn but has little effect on labor productivity. In the model, hiring inputs is risky because financial frictions limit firms' ability to insure against shocks that occur between the time of production and the receipt of revenues. Hence, an increase in idiosyncratic volatility induces firms to reduce their inputs to reduce such risk. We find that our model can generate about 67% of the decline in output of the Great Recession of 2007?2009.

Keywords: Recessions; Credit (search for similar items in EconPapers)
Date: 2012
New Economics Papers: this item is included in nep-bec, nep-dge and nep-mac
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Citations: View citations in EconPapers (51)

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Related works:
Journal Article: Financial Frictions and Fluctuations in Volatility (2019)
Working Paper: Financial Frictions and Fluctuations in Volatility (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedmsr:466

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