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Financial Crises and Fluctuations in Uncertainty

Author

Listed:
  • Yan Bai

    (Arizona State University)

  • Patrick Kehoe

    (Princeton University and Federal Reserve Bank of Minneapolis)

  • Cristina Arellano

    (Federal Reserve Bank of Minneapolis and University of Minnesota)

Abstract

The recent financial crisis has been accompanied by severe contractions in economic activity and credit as well as unprecedented levels of uncertainty. This project constructs a quantitative model with default risk where an increase in dispersion leads firms to contract the size of their projects to avoid default. High dispersion also has an amplification effect on firms output through tighter credit. Credit is more restricted because of the rise in aggregate default risk that comes with higher uncertainty. The model is calibrated to the cross section firm level data. We find that following a shock that increases dispersion, aggregate employment and output decline substantially especially when firms in the economy are highly leveraged.

Suggested Citation

  • Yan Bai & Patrick Kehoe & Cristina Arellano, 2010. "Financial Crises and Fluctuations in Uncertainty," 2010 Meeting Papers 1002, Society for Economic Dynamics.
  • Handle: RePEc:red:sed010:1002
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