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Financial Frictions and Fluctuations in Volatility

Arellano, C; Bai, Y; Kehoe, P; (2018) Financial Frictions and Fluctuations in Volatility. Journal of Political Economy 10.1086/701792. (In press).

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The U.S. Great Recession featured a large decline in output and labor, tighter financial conditions, and a large increase in firm growth dispersion. We build a model in which increased volatility at the firm level generates a downturn and worsened credit conditions. The key idea is that hiring inputs is risky because financial frictions limit firms’ ability to insure against shocks. An increase in volatility induces firms to reduce their inputs to reduce such risk. Our model can generate most of the decline in output and labor in the Great Recession and the observed increase in firms’ interest rate spreads.

Type: Article
Title: Financial Frictions and Fluctuations in Volatility
DOI: 10.1086/701792
Publisher version: https://doi.org/10.1086/701792
Language: English
Additional information: This version is the author accepted manuscript. For information on re-use, please refer to the publisher’s terms and conditions.
Keywords: Uncertainty shocks, Great Recession, Labor wedge, Firm heterogeneity, Credit constraints, Credit crunch, Firm credit spreads
UCL classification: UCL > Provost and Vice Provost Offices
UCL > Provost and Vice Provost Offices > UCL SLASH
UCL > Provost and Vice Provost Offices > UCL SLASH > Faculty of SandHS > Dept of Economics
URI: https://discovery.ucl.ac.uk/id/eprint/10054390
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