Financial Crises and Fluctuations in Uncertainty

Yan Bai, Patrick Kehoe and Cristina Arellano

No 1002, 2010 Meeting Papers from Society for Economic Dynamics

Abstract: The recent financial crisis has been accompanied by severe contractions in economic activity and credit as well as unprecedented levels of uncertainty. This project constructs a quantitative model with default risk where an increase in dispersion leads firms to contract the size of their projects to avoid default. High dispersion also has an amplification effect on firms output through tighter credit. Credit is more restricted because of the rise in aggregate default risk that comes with higher uncertainty. The model is calibrated to the cross section firm level data. We find that following a shock that increases dispersion, aggregate employment and output decline substantially especially when firms in the economy are highly leveraged.

Date: 2010
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed010:1002

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