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Does Financial Development Cause Higher Firm Volatility and Lower Aggregate Volatility?

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  • Shalini Mitra

    (University of Connecticut)

Abstract

The period before the financial crisis was characterized by unprecedented calm in the U.S. and other developed countries. Volatility of aggregate output growth declined in the U.S. beginning in the early 1980's until the fall of 2007 (the phenomenon has been widely called the Great Moderation). Meanwhile micro level evidence suggests increasing volatility at the firm level over the last 60 years including the period of the Great Moderation. I conduct a quantitative analysis of the role played by financial development in the divergence of firm and aggregate volatilities. In a DSGE setting based on Kiyotaki and Moore (1997) type borrowing constraints I show that financial development is associated with increasing firm growth volatility and declining aggregate volatility. The reason for the divergence is a decline in correlation of the firm with the aggregate as financial development occurs. Classification-JEL: D21, D58, E27, E32

Suggested Citation

  • Shalini Mitra, 2012. "Does Financial Development Cause Higher Firm Volatility and Lower Aggregate Volatility?," Working papers 2012-07, University of Connecticut, Department of Economics.
    • Handle: RePEc:uct:uconnp:2012-07
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    Cited by:

    1. Jeremy Greenwood & Juan M. Sanchez & Cheng Wang, 2010. "Financing Development: The Role of Information Costs," American Economic Review, American Economic Association, vol. 100(4), pages 1875-1891, September.

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    More about this item

    Keywords

    Great Moderation; Firm-Level Volatility; Borrowing Constraints; Heterogenous Firms; Business Cycle;
    All these keywords.

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D58 - Microeconomics - - General Equilibrium and Disequilibrium - - - Computable and Other Applied General Equilibrium Models
    • E27 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Forecasting and Simulation: Models and Applications
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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