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Does Financial Development Cause Higher Firm Volatility and Lower Aggregate Volatility?

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  • Shalini Mitra

    (University of Connecticut)

Abstract

The period before the financial crisis was characterized by unprecedented calm in the U.S. and other developed countries. Volatility of aggregate output growth declined in the U.S. beginning in the early 1980's until the fall of 2007 (the phenomenon has been widely called the Great Moderation). Meanwhile micro level evidence suggests increasing volatility at the firm level over the last 60 years including the period of the Great Moderation. I conduct a quantitative analysis of the role played by financial development in the divergence of firm and aggregate volatilities. In a DSGE setting based on Kiyotaki and Moore (1997) type borrowing constraints I show that financial development is associated with increasing firm growth volatility and declining aggregate volatility. The reason for the divergence is a decline in correlation of the firm with the aggregate as financial development occurs. Classification-JEL: D21, D58, E27, E32

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Bibliographic Info

Paper provided by University of Connecticut, Department of Economics in its series Working papers with number 2012-07.

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Length: 27 pages
Date of creation: Mar 2012
Date of revision:
Handle: RePEc:uct:uconnp:2012-07

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Related research

Keywords: Great Moderation; Firm-Level Volatility; Borrowing Constraints; Heterogenous Firms; Business Cycle;

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