Leverage and Deepening Business Cycle Skewness

63 Pages Posted: 28 Aug 2017

See all articles by Henrik Jensen

Henrik Jensen

University of Copenhagen - Department of Economics; Centre for Economic Policy Research (CEPR)

Ivan Petrella

University of Warwick; Centre for Economic Policy Research (CEPR)

Søren Hove Ravn

University of Copenhagen

Emiliano Santoro

University of Copenhagen - Department of Economics

Multiple version iconThere are 3 versions of this paper

Date Written: August 24, 2017

Abstract

We document that the U.S. economy has been characterized by an increasingly negative business cycle asymmetry over the last three decades. This finding can be explained by the concurrent increase in the financial leverage of households and firms. To support this view, we devise and estimate a dynamic general equilibrium model with collateralized borrowing and occasionally binding credit constraints. Higher leverage increases the likelihood that constraints become slack in the face of expansionary shocks, while contractionary shocks are further amplied due to binding constraints. As a result, booms become progressively smoother and more prolonged than busts. We are therefore able to reconcile a more negatively skewed business cycle with the Great Moderation in cyclical volatility. Finally, in line with recent empirical evidence, financially-driven expansions lead to deeper contractions, as compared with equally-sized non-financial expansions.

Keywords: Credit constraints, business cycles, skewness, deleveraging

JEL Classification: E32, E44

Suggested Citation

Jensen, Henrik and Petrella, Ivan and Ravn, Søren Hove and Santoro, Emiliano, Leverage and Deepening Business Cycle Skewness (August 24, 2017). Available at SSRN: https://ssrn.com/abstract=3025409 or http://dx.doi.org/10.2139/ssrn.3025409

Henrik Jensen (Contact Author)

University of Copenhagen - Department of Economics ( email )

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Centre for Economic Policy Research (CEPR)

London
United Kingdom

Ivan Petrella

University of Warwick ( email )

Gibbet Hill Rd.
Coventry, West Midlands CV4 8UW
United Kingdom

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Søren Hove Ravn

University of Copenhagen ( email )

Nørregade 10
Copenhagen, København DK-1165
Denmark

Emiliano Santoro

University of Copenhagen - Department of Economics ( email )

Øster Farimagsgade 5
Bygning 26
1353 Copenhagen K.
Denmark

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