Hernan J. Moscoso Boedo

Market Exposure and Endogenous Firm Volatility over the Business Cycle

We propose a theory of endogenous firm-level risk over the business cycle based on endogenous market exposure. Firms that reach a larger number of markets diversify market-specific demand shocks at a cost. The model is driven only by total factor productivity shocks and captures the observed countercyclity of firm-level risk. Using a panel of US firms we show that, consistent with our theoretical model, measures of market reach are procyclical, and the countercyclicality of firm-level risk is driven by those firms that adjust their market exposure, which are larger than those that do not. (JEL D21, D22, E23, E32, L25)

NEW FACTS ABOUT FIRM RISK ACROSS COUNTRIES AND OVER THE BUSINESS CYCLE

The characteristics of firm‐level risk over the cycle and across countries are studied in this paper. Low idiosyncratic firm‐level risk is found to be a feature of highly developed, stable economies, whereas the countercyclicality of firm‐level risk is associated with flexible as well as stable economies. These facts are uncovered with the help of a theoretical model where small, risk‐averse firms display procyclical risk, whereas larger, risk‐neutral firms have countercyclical risk patterns that depend on the rigidity of the business environment. The predictions of the model are then confirmed by the data using a large international firm‐level database (ORBIS) together with the World Bank Doing Business Database, during the “Great Recession” across 55 countries. The findings are critical for the growing literature of uncertainty driven business cycles, and show that firm‐level uncertainty cannot be treated as an exogenous parameter.