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Idiosyncratic Production Risk, Growth, and the Business Cycle

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Author Info
George-Marios Angeletos
Laurent Calvet

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Abstract

We introduce a neoclassical growth economy with idiosyncratic production risk and incomplete markets. Each agent is an entrepreneur operating her own neoclassical technology with her own capital stock. The general equilibrium is characterized in closed form. Idiosyncratic production shocks introduce a risk premium on private equity and reduce the demand for investment. The steady state is characterized by a lower capital stock due to entrepreneurial risk and a lower interest rate due to precautionary savings as compared to complete markets. The private equity premium is endogenously countercyclical: the anticipation of low savings and high interest rates in the future feed back to high risk premia and low investment in the present. Countercyclicality in risk taking slows down convergence to the steady state and amplifies the magnitude and persistence of the business cycle. These results, which contrast sharply with those obtained in Bewley models, highlight the macroeconomic significance of missing markets in production and investment risk.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9764.

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Date of creation: Jun 2003
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Handle: RePEc:nbr:nberwo:9764

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D5 - Microeconomics - - General Equilibrium and Disequilibrium
D9 - Microeconomics - - Intertemporal Choice and Growth

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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Thesmar, David & Thoenig, Mathias, 2009. "Contrasting Trends in Firm Volatility: Theory and Evidence," CEPR Discussion Papers 7135, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  2. Singh, Aarti, 2008. "Human capital risk in life-cycle economies," MPRA Paper 10292, University Library of Munich, Germany. [Downloadable!]
  3. Juan-Carlos Cordoba, 2004. "Debt-Constraints or Incomplete Markets? A Decomposition of the Wealth and Consumption Inequality in the U.S," Macroeconomics 0404004, EconWPA. [Downloadable!]
    Other versions:
  4. Christian Hellwig, 2002. "Signaling in a Global Game: Coordination and Policy Traps (J.P.E., June 2006)," UCLA Economics Online Papers 209, UCLA Department of Economics. [Downloadable!]
  5. Caterina Mendicino, 2008. "On the Amplification Role of Collateral Constraints," Working Papers 08-23, Bank of Canada. [Downloadable!]
    Other versions:
  6. Fabià Gumbau-Brisa, 2005. "Heterogeneous beliefs and inflation dynamics: a general equilibrium approach," Working Papers 05-16, Federal Reserve Bank of Boston. [Downloadable!]
  7. M. Fatih Guvenen, 2002. "Does Stockholding Provide Perfect Risk Sharing?," RCER Working Papers 490, University of Rochester - Center for Economic Research (RCER), revised Mar 2003. [Downloadable!]
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  8. Francisco Covas & Shigeru Fujita, 2007. "Private risk premium and aggregate uncertainty in the model of uninsurable investment risk," Working Papers 07-30, Federal Reserve Bank of Philadelphia. [Downloadable!]
  9. Anthony A. Smith, Jr., 2003. "The Research Agenda: Business Cycles and Inequality," EconomicDynamics Newsletter, Review of Economic Dynamics, vol. 4(2), April. [Downloadable!]
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  11. Dzhumashev, Ratbek, 2008. "Corruption and Disposable Risk," MPRA Paper 11772, University Library of Munich, Germany. [Downloadable!]
  12. Eva Carceles-Poveda, 2009. "Asset Prices and Business Cycles under Market Incompleteness," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(3), pages 405-422, July. [Downloadable!] (restricted)
    Other versions:
  13. Francisco Covas, 2005. "Uninsured Idiosyncratic Production Risk with Borrowing Constraints," Working Papers 05-26, Bank of Canada. [Downloadable!]
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  14. George-Marios Angeletos & Christian Hellwig & Alessandro Pavan, 2003. "Coordination and Policy Traps," NBER Working Papers 9767, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  15. Mark A. Carlson & Thomas B. King & Kurt F. Lewis, 2009. "Distress in the financial sector and economic activity," Finance and Economics Discussion Series 2009-01, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
    Other versions:
  16. George-Marios Angeletos & Laurent-Emmanuel Calvet, 2004. "Incomplete Market Dynamics in a Neoclassical Production Economy," NBER Working Papers 11016, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  17. George-Marios Angeletos, 2005. "Uninsured Idiosyncratic Investment Risk," NBER Working Papers 11180, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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