Uncertainty Shocks and Firm Dynamics: Search and Monitoring in the Credit Market

By Thomas Brand, Marlène Isoré and Fabien Tripier

http://d.repec.org/n?u=RePEc:cpm:docweb:1707&r=dge

We develop a business cycle model with gross flows of firm creation and destruction. The credit market is characterized by two frictions. First, entrepreneurs undergo a costly search for intermediate funding to create a firm. Second, upon a match, a costly-state-verification contract is set up. When defaults occurs, banks monitor firms, seize their assets, and a fraction of financial relationships are severed. The model is estimated using Bayesian methods for the U.S. economy. Among other shocks, uncertainty in productivity turns out to be a major contributor to both macro-financial aggregates and firm dynamics.

This is an interesting that brings an additional layer to the financing part of the typical business cycle model. Entrepreneurs search and are subject to CSV. Also the model is estimated. It is not a surprise that in such a set-up second moments matter, but it worth emphasizing once more uncertainty is important.