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Are fluctuations in firms' profitability risk a major cause of regular business cycles? We study this question within the framework of a heterogeneous-firm dynamic stochastic general equilibrium model with fixed capital adjustment costs. In such a model, surprise increases of risk lead to a wait-and-see policy for investment at the firm level and a decrease in aggregate economic activity. We calibrate the model using German firm-level data with a broader sectoral, size and ownership coverage than comparable U.S. data sets. The use of these data enables us to provide robust lower and upper bound estimates for the size of firm-level risk fluctuations. We find that time-varying firm-level risk on its own is unlikely to be a major quantitative source of regular business cycle fluctuations. When we augment a model with only aggregate productivity shocks by time-varying risk, the risk shocks dampen the high contemporaneous correlations of the productivity-shock-only model, but do not alter the other unconditional business cycle properties.
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We document a new business cycle fact: the cross-sectional standard deviation of firm-level investment (investment dispersion) is robustly and significantly procyclical. This makes investment dispersion different from the dispersion of productivity and output growth, which is countercyclical. Investment dispersion is more procyclical in the goods-producing sectors, for smaller firms and for structures. We show that a heterogeneous-firm real business cycle model with countercyclical idiosyncratic firm risk and non-convex adjustment costs calibrated to match moments of the long-run investment rate distribution, produces a time series correlation coefficient between investment dispersion and aggregate output of 0.58, close to the 0.45 in the data. We argue, more generally, that cross-sectional business cycle dynamics impose tight empirical restrictions on the physical environments and the structural parameters of heterogeneous-firm models.
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Are fluctuations in firms' profitability risk a major cause of regular business cycles? We study this question within the framework of a heterogeneous-firm dynamic stochastic general equilibrium model with fixed capital adjustment costs. In such a model, surprise increases of risk lead to a wait-and-see policy for investment at the firm level and a decrease in aggregate economic activity. We calibrate the model using German firm-level data with a broader sectoral, size and ownership coverage than comparable U.S. data sets. The use of these data enables us to provide robust lower and upper bound estimates for the size of firm-level risk fluctuations. We find that time-varying firm-level risk on its own is unlikely to be a major quantitative source of regular business cycle fluctuations. When we augment a model with only aggregate productivity shocks by time-varying risk, the risk shocks dampen the high contemporaneous correlations of the productivity-shock-only model, but do not alter the other unconditional business cycle properties.
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We document a new business cycle fact: the cross-sectional standard deviation of firm-level investment (investment dispersion) is robustly and significantly procyclical. This makes investment dispersion different from the dispersion of productivity and output growth, which is countercyclical. Investment dispersion is more procyclical in the goods-producing sectors, for smaller firms and for structures. We show that a heterogeneous-firm real business cycle model with countercyclical idiosyncratic firm risk and non-convex adjustment costs calibrated to match moments of the long-run investment rate distribution, produces a time series correlation coefficient between investment dispersion and aggregate output of 0.58, close to the 0.45 in the data. We argue, more generally, that cross-sectional business cycle dynamics impose tight empirical restrictions on the physical environments and the structural parameters of heterogeneous-firm models.
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