Firm Risk and Leverage-Based Business Cycles

I characterize cyclical fluctuations in the cross-sectional dispersion of firm-Level productivity. Using the micro-estimated dispersion, or "risk," stochastic process as an input to a baseline small-scale nancial accelerator model, I assess how well the model reproduces cyclical movements in both real and ?nancial conditions of the economy. In the model, risk shocks calibrated to micro data lead to empirically-relevant steady-state leverage, a financial measure typically thought to be closely associated with real activity. In terms of aggregate quantities, pure risk shocks in the small-scale general equilibrium model account for a notable share of GDP fluctuations — roughly 5%. The volatility of the risk process I measure using micro data is, remarkably, not very di?erent compared to recent estimates of risk shocks based on medium- or large-scale models using macroeconomic data. These seemingly contrasting starting points for measuring risk shocks do not imply any dichotomy at the core of a popular class of DSGE ?nancial frictions models. Rather, it is the particular transmission channels in financial frictions models — whether small scale or medium scale — that are critical for aggregate quantity uctuations to arise based on risk shocks.