Bubbly Firm Dynamics and Aggregate Fluctuations

Abstract

This study generalizes a standard heterogeneous firm model with endogenous entry and exit by allowing for asset bubbles. We highlight the selection effect of bubbles that incentivizes low-productivity firms to enter or remain in the market. We show that a rise in the aggregate bubble can boost real economic activities by increasing the number of entrants and decreasing the number of exits. Using firm-level data, we find that an overvalued firm is less likely to exit the market, which supports the novel transmission channel of bubbles. Moreover, we show that the model-implied impulse responses are consistent with those identified in the data. Finally, we demonstrate that a model without bubbles fails to reproduce our empirical findings.

Keywords: Rational Bubbles, Firm Dynamics, Heterogeneous Firms

JEL Classification: E32, E44, E47