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Firm-Specific Productivity Risk over the Business Cycle: Facts and Aggregate Implications

  • Ruediger Bachmann
  • Christian Bayer

Is time-varying firm-level uncertainty a major cause or amplifier of the business cycle? This paper investigates this question in the context of a heterogeneous-firm RBC model with persistent firm-level productivity shocks and lumpy capital adjustment, where cyclical changes in uncertainty correspond naturally to cyclical changes in the cross-sectional dispersion of firm-specific Solow residual innovations. We use a German firm-level data set to investigate the extent to which firm-level uncertainty varies over the cycle. This allows us to put empirical discipline on our numerical simulations. We find that, while firm-level uncertainty is indeed countercyclical, it does not fluctuate enough to significantly alter the dynamics of an RBC model with only first moment shocks. The mild changes we do find are mainly caused by a bad news effect: higher uncertainty today predicts lower aggregate Solowresiduals tomorrow. This effect dominates the real option value effect of time-varying uncertainty, highlighted in the literature.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 2844.

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Date of creation: 2009
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Handle: RePEc:ces:ceswps:_2844
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