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Idiosyncratic Production Risk, Growth and the Business Cycle

Author

Listed:
  • Laurent E. Calvet

    (NBER - The National Bureau of Economic Research, Department of Economics, Harvard University - Harvard University)

  • George-Marios Angeletos

    (NBER - The National Bureau of Economic Research, Department of Economics - MIT - Massachusetts Institute of Technology)

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.

Suggested Citation

  • Laurent E. Calvet & George-Marios Angeletos, 2012. "Idiosyncratic Production Risk, Growth and the Business Cycle," Working Papers hal-00674230, HAL.
    • Handle: RePEc:hal:wpaper:hal-00674230
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    JEL classification:

    • D5 - Microeconomics - - General Equilibrium and Disequilibrium
    • D9 - Microeconomics - - Micro-Based Behavioral Economics

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