Risky Business Cycles

Is there any other major macroeconomic idea you hear so little about outside the halls of academia?:

We identify a shock that explains the bulk of fluctuations in equity risk premia, and show that the shock also explains a large fraction of the business-cycle comovements of output, consumption, employment, and investment. Recessions induced by the shock are associated with reallocation away from full-time permanent positions, towards part-time and flexible contract workers. A real model with labor market frictions and fluctuations in risk appetite can explain all of these facts, both qualitatively and quantitatively. The size of risk-driven fluctuations depends on the relationship between the riskiness and productivity of different stores of value: if safe savings vehicles have relatively low marginal products, then a flight to safety will drive a larger aggregate contraction.

That is from a new NBER working paper by Susanto Basu, GiacomoCandian, Ryan Chahrout, and Rosen Valchev, and you will find related ideas in my 1998 book Risk and Business Cycles and also the earlier work of Fischer Black.



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