Firm Risk and Leverage-Based Business Cycles

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IZA Seminar

Place: Schaumburg-Lippe-Str. 9, 53113 Bonn

Date: 27.05.2010, 12:15 - 13:30


Presentation by 

Sanjay K. Chugh (Boston College)


I quantify the properties of cyclical fluctuations in the cross-sectional dispersion of firm-level risk, and I quantify the properties of cyclical fluctuations in aggregate leverage ratios, along with the debt and equity components separately, in the U.S. non-financial corporate sector. Using the estimated "risk shock" process as an input to a baseline DSGE financial-accelerator framework, I assess how well the model explains business-cycle fluctuations in the financial conditions of non-financial firms. In the model, risk shocks calibrated to micro data can account for virtually all of the business-cycle volatility of leverage, debt, and equity. In terms of aggregate quantities, however, pure risk shocks account for only a small share of GDP fluctuations in the model, less than two percent. Instead, it is standard TFP shocks that explain virtually all of the model's real fluctuations. Hence, the results suggest a type of dichotomy present at the core of a standard class of DSGE financial frictions models: risk shocks lead to large financial fluctuations, but these are largely isolated from macro fluctuations.

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