In the data, cross-sectional productivity dispersion is countercyclical at both the plant level and the firm level, see e.g. Bloom (2009). I incorporate a firm's choice of risk level into a model of firm dynamics with real business cycle features to explain this empirical finding both qualitatively and quantitatively. In the model, in every period, each firm chooses the investment amount and the risk level associated with a production project every period.

All projects available to each firm have the same expected flow return, determined by the aggregate and idiosyncratic shocks to the firm's productivity, and differ from one another only in their risk. The endogenous option of exiting the market and the limited funding for new investment jointly play an important role in motivating firms' risk-taking behavior.

The model predicts that, in each period, relatively small firms are more likely to take risk and hence exhibit a higher exit rate, and that the cross-sectional productivity dispersion, measured as the standard deviation of the realized individual component of productivity, is larger in recessions.

Riskiness, endogenous productivity dispersion and business cycles

Tue 26 May 2015 11:00amMon 11 Jan 2016 12:00pm


Room 629, Colin Clark Building (#39)