Credit Market Frictions and the Linkage between Micro and Macro Uncertainty

Abstract

This paper proposes a quantitative general equilibrium model with credit market frictions to explain the observed stylized facts of micro uncertainty (dispersion of realized firm-level outcomes) and macro uncertainty (volatility of aggregate economic variables). They are conceptually different but strongly comove and are countercyclical. In my model economy, an increase in the dispersion of idiosyncratic shocks leads to more firms in the left tail of the distribution to default, which reduces the aggregate net worth. Therefore, the economy becomes more leveraged and more sensitive to aggregate shocks when micro uncertainty is high, and the aggregate economy is more volatile.

Keywords: Uncertainty, Volatility, Dispersion, Financial Frictions, Asset Pricing

JEL Classification: D8, E3, G12