IDEAS home Printed from
   My bibliography  Save this paper

A Model of Working Capital with Idiosyncratic Production Risk and Firm Failure


  • George McCandless

    () (Central Bank of Argentina)


This paper is a contribution to the literature on possible pro-cyclical effects of capital rules under Basil 2 capital regulations. The addition of both idiosyncratic uncertainty and risk averse managers to a cash-in-advance model with financial intermediaries that finance working capital changes the way that the interest rate paid by borrowers responds to technology shocks and the correlation of these interest rates with output. Without idiosyncratic uncertainty, the interest rate for working capital borrowed by the firms is positively, and highly, correlated with output. Once idiosyncratic technology shocks are added, the correlation between the interest rate for working capital borrowed by the firms and output becomes highly negatively correlated. In stationary states, increases in the idiosyncratic shocks cause the risk averse firm managers to produce at levels where average total costs are well below average output, providing them with a partial cushion against a very low idiosyncratic shock. When absolute risk aversion is high, the e¤ect is to dampen the e¤ects of monetary shocks in the economy with idiosyncratic risk, but when absolute risk aversion is low, the effects of monetary shocks on real variables is higher, the larger the idiosyncratic risk.

Suggested Citation

  • George McCandless, 2006. "A Model of Working Capital with Idiosyncratic Production Risk and Firm Failure," BCRA Working Paper Series 200610, Central Bank of Argentina, Economic Research Department.
  • Handle: RePEc:bcr:wpaper:200610

    Download full text from publisher

    File URL:
    Download Restriction: no

    References listed on IDEAS

    1. Hansen, Gary D., 1985. "Indivisible labor and the business cycle," Journal of Monetary Economics, Elsevier, vol. 16(3), pages 309-327, November.
    2. Douglas W. Diamond, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Oxford University Press, vol. 51(3), pages 393-414.
    Full references (including those not matched with items on IDEAS)

    More about this item


    Basel II; capital rules; cash-in-advance model; credit pro-cyclicality; working capital;

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation


    Access and download statistics


    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bcr:wpaper:200610. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Federico Grillo). General contact details of provider: .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.