Granular Uncertainty and Disastrous Misallocation

57 Pages Posted: 10 Apr 2020 Last revised: 10 Sep 2020

See all articles by Winston Dou

Winston Dou

The Wharton School, University of Pennsylvania

Yan Ji

Hong Kong University of Science & Technology (HKUST)

Pengfei Wang

HKUST, Department of Economics; Hong Kong University of Science & Technology (HKUST) - Department of Economics

Date Written: September 8, 2020

Abstract

We develop a general equilibrium model in which heterogeneous entrepreneurs produce output in the presence of financing constraints. We model granular uncertainty as the shocks that affect the uncertainty in future idiosyncratic productivity without changing the cross-sectional dispersion of productivity. These shocks give rise endogenously to rare disasters through credit misallocation. Intuitively, an increase in granular uncertainty exacerbates the misallocation of credit as productive entrepreneurs' self-financing ability through saving becomes weaker when their productivity becomes transitory. In the presence of financial frictions, the recovery from the state with large misallocation is slow. We propose an approximation method to solve the model without tracking the exact distribution of agents. We show heuristically and numerically that the covariance of cross-sectional wealth and productivity can accurately summarize the economy's aggregate states. Our approximation method provides a closed-form characterization for both the steady states and transitional dynamics of the economy.

Keywords: Misallocation, Firm distribution, Financial constraints, Idiosyncratic shocks, Volatility, Slow recovery, Nonlinear dynamics.

JEL Classification: D61, D81, E32, G12

Suggested Citation

Dou, Winston and Ji, Yan and Wang, Pengfei, Granular Uncertainty and Disastrous Misallocation (September 8, 2020). Available at SSRN: https://ssrn.com/abstract=3540012 or http://dx.doi.org/10.2139/ssrn.3540012

Winston Dou (Contact Author)

The Wharton School, University of Pennsylvania ( email )

2318 Steinberg Hall - Dietrich Hall
3620 Locust Walk
Philadelphia, PA 19104
United States

Yan Ji

Hong Kong University of Science & Technology (HKUST) ( email )

Clearwater Bay
Kowloon, 999999
Hong Kong

Pengfei Wang

HKUST, Department of Economics ( email )

Clearwater Bay
Kowloon, 999999
Hong Kong

Hong Kong University of Science & Technology (HKUST) - Department of Economics ( email )

Clear Water Bay
Kowloon, Hong Kong
China

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