On balance sheets, idiosyncratic risk and aggregate volatility

Research output: Contribution to journalArticle

1 Citation (Scopus)

Abstract

Since the mid-1980s firm level financial volatility has increased, while the U.S. economy has experienced a sharp decline in the volatility of GDP growth. Do firms adjust their capital structure in response to higher idiosyncratic risk? And if so, could that affect the performance of the aggregate economy? Using a dynamic general equilibrium model we show that in the presence of larger firm-specific risk, firms shift the composition of their balance sheets towards more self-financing and away from debt. In the presence of financial accelerator-like frictions, larger idiosyncratic risk translates into greater external financing costs, steering firms to borrow less to counteract larger premia. Model simulations suggest that larger idiosyncratic risk dampens the financial accelerator and can lead to a reduction in output volatility of up to 40 percent; and up to a 16 percent decline in firm leverage.

Original languageEnglish
Article number4
JournalB.E. Journal of Macroeconomics
Volume9
Issue number1
StatePublished - 20 Apr 2009

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Balance sheet
Idiosyncratic risk
Financial accelerator
Dynamic general equilibrium model
Model simulation
Debt
GDP growth
Leverage
Output volatility
Self-financing
External financing
Friction
Capital structure
US economy
Large firms
Costs
Firm risk

Keywords

  • Capital structure
  • Firm risk
  • Output volatility

Cite this

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On balance sheets, idiosyncratic risk and aggregate volatility. / Portes, Luis San Vicente; Ozenbas, Deniz.

In: B.E. Journal of Macroeconomics, Vol. 9, No. 1, 4, 20.04.2009.

Research output: Contribution to journalArticle

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