Idiosyncratic production risk, growth, and the business cycle

56 Pages·2002·2.4 MB·English

by  Angeletos, Marios

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OBWEY
5
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Massachusetts Institute of Technology
Department of Economics
Working Paper Series
IDIOSYNCRATIC PRODUCTION RISK, GROWTH,
AND THE BUSINESS CYCLE
George-Marios Angeletos
Laurent E. Calvet
Working Paper 02-10
February 2002
Room
E52-251
50 Memorial Drive
MA
Cambridge, 021 42
This paper can be downloaded without charge from the
Social Science Research Network Paper Collection at
http://papers.ssrn.com/paper.taf?abstract_id=xxxxx

loO
Massachusetts Institute of Technology
Department of Econonnics
Working Paper Senes
IDIOSYNCRATIC PRODUCTION RISK, GROWTH,
AND THE BUSINESS CYCLE
George-Marios Angeletos
Laurent E. Calvet
Working Paper 02-10
February 2002
Room
E52-251
50 Mennorial Drive
MA
Cambridge, 02142
This paper can be downloaded without charge from the
Social Science Research Network Paper Collection at
http://papers.ssrn.com/paper.taf?abstract_id=xxxxx
MASSACHUSEHS INSTITUTE
OFTECHNOLOGY
MAR 1 5 2002
LIBRARIES
Idiosyncratic Production Risk,
Growth, and the Business Cycle
George-Marios Angeletos and Laurent E. Calvet*
MIT and Harvard University
This draft: February 2002
We examine a neoclassical growth economy with idiosj'ncratic production risk and incomplete
markets. Under a CARA-nomial specification for preferences and risk, we characterize the
general equilibrium in closed form. Uninsurableproduction shocks introduce arisk premium on
private equity, and typically result in a lower steady-state level of capital than under complete
markets. Inthe presenceofsuchrisks, the anticipationoffuturelow investmentandhighinterest
rates discourages current risk-taking and feeds bcick into low investment in the present. An
endogenous macroeconomic complementarity thus arises, which can amplif\' the magnitude and
the persistence ofthe busmess cycle. These results - contrasting sharply with those ofAiyagari
(1994) and KrusellandSmith (1998) -highlight thatidiosyncratic productionor entrepreneurial
risks can have significant adverse effects on capital accumulation and aggregate volatility.
Keywords: Entrepreneurial Risk, Investment, Growth, Fluctuations, Precautionary Savings.
JEL Classification: D5, D9, E2, E3, 01.
MA
'Correspondence: 50 Memorial Drive, Cambridge, 02142, [email protected]; Littauer Center, Cambridge,
MA
02138, [email protected]. This manuscript is a thoroughly revised version of an earlier working
paper, "Incomplete Markets, Growth, and the Business Cycle". We are especially grateful to Abhijit Banerjee,
Robert Barro and John Campbell for detailed feedback and extensivediscussions. We also received helpful comments
from D. Acemoglu, P. Aghion, A. Alesina, J. Benhabib, A. Bisin, R. Caballero, F. Caselli, C. Foote, O. Galor, J.
Geanakoplos, M. Gertler, J.M. Grandmont, O. Hart, N.Kiyotaki, D. Laibson, N.G. Mankiw,M.Mobius, G.Moscarini,
H. Polemarchakis, M. Schwarz, K. Shell, R. ShiUer, C. Sims, R. Townsend, T. Vuolteenaho, and seminar participants
at Brown, Harvard, Maryland, MIT, NYU, Yale, the 2000 Conference ofthe Society ofEconomic Dynamics, and the
2001 Minnesota Summer Macro Workshop.