Financial Frictions and Fluctuations in Volatility / Cristina Arellano, Yan Bai, Patrick J. Kehoe.

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Arellano, Cristina

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Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w22990.Publication details: Cambridge, Mass. National Bureau of Economic Research 2016.Description: 1 online resource: illustrations (black and white)Subject(s):

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Abstract: During the recent U.S. financial crisis, the large decline in aggregate output and labor was accompanied by both a tightening of financial conditions and a large increase in the dispersion of growth rates across firms. The tightened financial conditions manifested themselves as increases in firms' credit spreads and decreases in both equity payouts and debt purchases. These features motivate us to build a model in which increased volatility of firm level productivity shocks generates a downturn and worsened credit conditions. The key idea in the model is that hiring inputs is risky because financial frictions limit firms' ability to insure against shocks. Hence, an increase in idiosyncratic volatility induces firms to reduce their inputs to reduce such risk. We find that our model can generate most of the decline in output and labor in the Great Recession of 2007-2009 and the observed tightening of financial conditions.

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Item type	Home library	Collection	Call number	Status	Date due	Barcode	Item holds
Working Paper	Biblioteca Digital	Colección NBER	nber w22990 (Browse shelf(Opens below))	Not For Loan

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December 2016.

During the recent U.S. financial crisis, the large decline in aggregate output and labor was accompanied by both a tightening of financial conditions and a large increase in the dispersion of growth rates across firms. The tightened financial conditions manifested themselves as increases in firms' credit spreads and decreases in both equity payouts and debt purchases. These features motivate us to build a model in which increased volatility of firm level productivity shocks generates a downturn and worsened credit conditions. The key idea in the model is that hiring inputs is risky because financial frictions limit firms' ability to insure against shocks. Hence, an increase in idiosyncratic volatility induces firms to reduce their inputs to reduce such risk. We find that our model can generate most of the decline in output and labor in the Great Recession of 2007-2009 and the observed tightening of financial conditions.