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Financial Distress and Endogenous Uncertainty

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  • Francois Gourio

    (Boston University)

Abstract

A large amount of recent research in macroeconomics emphasizes the role of uncertainty as a driver of business cycles, but the majority of this work takes uncertainty as exogenous. This paper proposes a model where aggregate uncertainty is endogenously time-varying through financial distress costs. As firms become closer to default, their employment and investment demand is reduced by debt overhang. Moreover, firms' productivity may also be directly reduced by higher transaction costs. These two mechanisms make macroeconomic aggregates more volatile when a large number of firms have low equity value. The cross-sectional distribution of firms' equity values hence affects directly aggregate macroeconomic volatility. Empirical evidence consistent with the model is provided.

Suggested Citation

  • Francois Gourio, 2013. "Financial Distress and Endogenous Uncertainty," 2013 Meeting Papers 108, Society for Economic Dynamics.
    • Handle: RePEc:red:sed013:108
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    Cited by:

    1. Contessi, Silvio & De Pace, Pierangelo & Guidolin, Massimo, 2020. "Mildly explosive dynamics in U.S. fixed income markets," European Journal of Operational Research, Elsevier, vol. 287(2), pages 712-724.
    2. Alexander W. Richter & Nathaniel A. Throckmorton, 2017. "A New Way to Quantify the Effect of Uncertainty," Working Papers 1705, Federal Reserve Bank of Dallas.
    3. Tyler Atkinson & Michael Plante & Alexander Richter & Nathaniel Throckmorton, 2022. "Complementarity and Macroeconomic Uncertainty," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 44, pages 225-243, April.
    4. Miescu, Mirela S., 2023. "Uncertainty shocks in emerging economies: A global to local approach for identification," European Economic Review, Elsevier, vol. 154(C).
    5. van Wijnbergen, Sweder & Jakucionyte, Egle, 2017. "Debt Overhang, Exchange Rates and the Macroeconomics of Carry Trade," CEPR Discussion Papers 11788, C.E.P.R. Discussion Papers.
    6. Ilut, Cosmin & Saijo, Hikaru, 2021. "Learning, confidence, and business cycles," Journal of Monetary Economics, Elsevier, vol. 117(C), pages 354-376.
    7. Petr Sedláček, 2020. "Creative Destruction and Uncertainty," Journal of the European Economic Association, European Economic Association, vol. 18(4), pages 1814-1843.
    8. Marek Ignaszak & Petr Sedlácek, 2021. "Profitability, Productivity and Growth," Economics Series Working Papers 937, University of Oxford, Department of Economics.
    9. Abakah, Emmanuel Joel Aikins & Caporale, Guglielmo Maria & Gil-Alana, Luis Alberiko, 2021. "Economic policy uncertainty: Persistence and cross-country linkages," Research in International Business and Finance, Elsevier, vol. 58(C).

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