Uncertainty Driven Entry and Exit Over the Business Cycle
50 Pages Posted: 16 Dec 2018
Date Written: September 07, 2018
This paper explores the aggregate implications of countercyclical macroeconomic volatility. First, by drawing on data of publicly traded U.S. firms, I find that both the investment rate and the probability of investment spikes decrease as macroeconomic volatility rises, with this effect weakening as firms age. Second, to rationalize empirical patterns, I build an uncertainty regime-switching general equilibrium model of investment with capital adjustment costs and firms’ entry and exit. In the model, mature firms are close to their long-run productivity, and therefore, do not respond strongly to heightened uncertainty. Conversely, young firms are far away from their long-run productivity, and prefer to "freeze" their investment decisions during volatile times. Finally, in contrast to existing literature, I show that the entry/exit margin can be quantitatively important, especially during high-uncertainty episodes such as the Great Recession.
Keywords: Uncertainty Shocks, Business Cycles, Firm Dynamics
JEL Classification: E22, E32
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