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« Back to Results

Macro Finance

Paper Session

Friday, Jan. 5, 2018 2:30 PM - 4:30 PM

Loews Philadelphia, Regency Ballroom C1
Hosted By: American Finance Association
  • Chair: Timothy James McQuade, Stanford University

Slow Recovery With Uncertainty Shocks and Optimal Firm Liquidation

Indrajit Mitra
,
University of Michigan

Abstract

I analyze optimal dynamic contracting between risk-averse investors and firm
insiders in a dynamic general equilibrium model with heterogeneous firms. Borrowing constraints arise endogenously in this economy because investors do not observe firm output. I quantify the effect of aggregate uncertainty shocks and show that with realistic parameters, such shocks can lead to recessions with a 4% drop in GDP. It takes 8 quarters for GDP to return to pre-crisis levels after uncertainty reverts back to lower levels. This slow recovery is due to a large increase in the severity of the agency problem faced by small and medium-sized firms. A significant fraction of these firms sharply reduce investment both during the recession and several quarters into the recovery phase. In contrast, a negative first moment shock to productivity generates a fast recovery from a similar drop in GDP.

The Finance Uncertainty Multiplier

Ivan Alfaro
,
BI Norwegian Business School
Nicholas Bloom
,
Stanford University
Xiaoji Lin
,
Ohio State University

Abstract

We show how real and financial frictions amplify the impact of uncertainty shocks. We start by building a model with real frictions, and show how adding financial frictions roughly doubles the negative impact of uncertainty shocks. The reason is higher uncertainty alongside financial frictions induces the standard negative real-options effects on the demand for capital and labor, but also leads firms to hoard cash against future shocks, further reducing investment and hiring. We then test the model using a panel of US firms and a novel instrumentation strategy for uncertainty exploiting differential firm exposure to exchange rate and factor price volatility. Consistent with the model we find that higher uncertainty reduces firms' investment, hiring, while increasing their cash holdings and cutting their dividend payouts, particularly for financially constrained firms. This highlights why in periods with greater financial frictions -- like during the global-financial-crisis -- uncertainty can be particularly damaging.

Finance in a Time of Disruptive Growth

Nicolae Gârleanu
,
University of California-Berkeley
Stavros Panageas
,
University of California-Los Angeles

Abstract

Increased arrival of new technologies and displacement of old technologies leads to increased heterogeneity of investment income across investors. Investors who find themselves with high exposures to successful new firms and entrepreneurs win a disproportionate share of profits, while those who hold lower exposures may end up with a lower fraction of aggregate investment income. Using a novel data set on the wealth of ultra-high net worth individuals, we document the rapid ascension to wealth by self-made businesspeople in the last decades. We then study the implications of redistributive growth for finance and macro and compare them to trends recently observed in financial markets. We show that ``alternative asset classes'' as diverse as commercial real estate, commodities, and private equity offer hedging and diversification benefits in a world of increased displacement, and therefore experience inflows. The same applies to zero-net supply risk free investments, leading to a drop in the risk free rate. The resources accruing to the financial industry increase, but (irreversible) investment in specialized equipment and structures may not, despite the lower required rates of return. Surprisingly, there is a positive gap between the expected returns of investments in new versus existing firms, despite the diversification benefits offered by the former.

Levered Ideas: Risk Premia Along the Credit Cycle

Wenxi Liao
,
Duke University
Lukas Schmid
,
Duke University

Abstract

We quantitatively evaluate a general equilibrium model in which the endogenous supply of collateral drives the joint dynamics of credit, risk and risk premia. Endogenous adoption facilitates the transformation of intangible ideas into technology that productive firms can borrow against. In the model, the arrival of new technologies drives the ratio between ideas and collateralizable capital (IC ratio) which is a significant predictor of leverage and returns in stock and corporate bond markets. In particular, a high IC ratio predicts an endogenously high market price of risk and high unlevered returns to technology adoption, while a low IC ratio comes with a low equilibrium market price of risk but high levered returns. Interpreted in the context of venture capitalists (adopters) and buyout funds (levered firms), the model rationalizes repeated, but distinct, venture capital and buyout waves, and returns. VC waves occur when the equilibrium price of risk is elevated, while buyout volume spikes when credit risk premia are endogenously low. Quantitatively, our model of a credit cycle driven by the slow transformation of new ideas into collateralizable assets rationalizes well the predictability evidence in stock and corporate bond markets. Empirically, we document that innovation measures forecast aggregate leverage, credit spreads and credit risk premia, as well as buyout activity, in line with model predictions.
Discussant(s)
Benjamin Hebert
,
Stanford University
Simon Gilchrist
,
Boston University
Dimitris Papanikolaou
,
Northwestern University
Jack Favilukis
,
University of British Columbia
JEL Classifications
  • G0 - General