Essays on business cycles with liquidity constraints and firm entry-exit dynamics under incomplete information

This dissertation addresses two distinct issues. The first paper studies business cycles with asset fire sales under limited commitment in financial markets. Paper 2 and 3 study firm entry and exit dynamics in a global game with incomplete information. The second paper derives analytical solutions when firms’ productivity is uniformly distributed. The third paper extends the analysis to span more general distributions and solves the problem numerically.The first paper develops a stochastic over-lapping generations’ model to study the intertemporal and intergenerational transmission of productivity shocks. Productivity shocks cause fire sales of capital, which in turn affects the income of future generations. From a constrained-efficiency perspective, competitive equilibria can be inefficient as agents' choices in equilibrium exhibit ex-ante over-borrowing. The inefficiency arises because entrepreneurs cannot get fully financed from outside funds due to limited commitment in financial markets. The fact that the capital prices are determined in competitive markets also contributes to the above inefficiency because agents fail to internalize potential ex-post fire sales. A capital requirement policy can reduce fire sales when adverse productivity shocks occur, and can thus increase the income for all future generations. On the other hand, a lower capital stock even when good productivity shocks occur decreases income for all future generations. Overall, this paper shows that in the long run, a capital requirement policy can (strictly) increase welfare of agents.The second paper develops a static general equilibrium model to study firms' entry and exit decision in a global game with incomplete information. Firms' choices are strategic substitutes. This paper analytically proves the existence and uniqueness of a monotonic pure strategy equilibrium when the mean productivity and the productivity conditional on the mean are both drawn from uniform distributions. Using numerical examples, it is shown that when the precision of public information increases, the equilibrium switching productivity level increases and, as a result, the aggregate industry productivity increases. By reallocating resources to more productive firms, an increase in the precision of public information leads to a higher welfare.The third paper extends the problem studied in the second paper to examine whether and how the shapes of productivity distributions affect the existence of the monotonic pure strategy equilibria. The mean productivity is now drawn from a truncated normal distribution and individual firm's productivity conditional on the mean is drawn from more general (truncated) distributions, such as truncated normal, truncated gamma, and truncated exponential distributions. With numerical examples, it is shown that a unique monotonic pure strategy equilibrium continues to exist when firms’ productivity is drawn from non-uniform distributions. As in paper 2, both the aggregate productivity and the welfare per worker increase with the increase in the precision of public information. However, unlike in paper 2, the impact of an increase in the precision of private information on aggregate productivity and the welfare depends on the shape of the distribution. In particular, this impact is uncertain when the productivity conditional on the mean is drawn from truncated gamma distribution, which is skewed.