Business Cycle Patterns Research Articles

Did COVID‐19 induce a reallocation wave?

AbstractWe critically examine the hypothesis that COVID‐19 has ushered in a large reallocation shock in the USA, beyond typical business cycle patterns. We take a broad perspective, and first consider data from the CPS and JOLTS; there is no noticeable uptick in occupation or sector switches, either at the aggregate level or in the cross‐section. The dispersion of sectoral growth rates over the three years before the pandemic was similar to the previous period. The recovery from the initial shock was characterized by very high quits and low layoffs, patterns indicative of a strong labour market, not excessively high reallocation relative to previous business cycles. High growth of small employers in the recovery, and larger ones once the labour market tightened, is also a common cyclical pattern. We then examine whether mismatch unemployment rose as a result of the pandemic; using an off‐the‐shelf multisector search and matching model, there is little evidence for an important role for mismatch in driving the unemployment rate during the pandemic. Finally, we employ a novel Bayesian Structural Vector Autoregression framework with sign restrictions to identify a reallocation shock; we find that it has played a relatively minor role in explaining labour market patterns in the pandemic, at least relative to earlier episodes.

A Post-Mortem of the Life Insurance Industry's Bid for Capital During the Financial Crisis

In this paper, we show that life insurance companies were under significant capital strain during the recent financial crisis. This was the case not just for the notable case of American International Group (AIG), or for life insurers within the largest life insurance groups that applied for government funds, but for life insurers across the entire industry. The ability to access government funds, the benefit of regulatory actions and the large internal capital transfers received by life insurers from their non-insurance parents during the crisis combined to contribute significant amounts of reported statutory capital to life insurance companies. Moreover, capital contributions to life insurers from their parents are not limited to crisis periods; they also exhibit a business cycle pattern. This study provides evidence suggesting two important policy recommendations and calls for additional research on these issues: 1) insurance supervisors should have the ability to assess capital adequacy and availability beyond the level of the insurance operating company, including the ability to assess the capital adequacy of, and availability of capital from, holding companies not currently supervised by state insurance regulators, and these supervisors should take a consolidated view in monitoring the size, type and direction of internal capital transfers when evaluating the viability of entity-level life insurers; and 2) life insurance supervisors would benefit from staff with expertise in understanding and forecasting the impact of macroeconomic and financial conditions on life insurers’ balance sheets.

Endogenous lemons markets and information cycles

This article develops a dynamic stochastic general equilibrium model in which information on capital quality is asymmetric and the degree of information asymmetry varies endogenously with the state of the economy, amplifying the shocks. Firms hold capital and borrow to cover operating expenses. Production is subject to idiosyncratic shocks. When a firm’s realized revenue is not enough to cover its debt obligation, the firm must liquidate capital in a market that is subject to the lemons problem. During production, some of the firms' capital depreciates, becoming “lemons”. Firms initially have no information on which units of their capital have depreciated, but they can acquire private information on the quality of their own capital at a cost, which allows them to select low-quality capital to sell during liquidation. Although private information acquisition can be individually beneficial, it generates the lemons problem, decreasing market liquidity and distorting economic allocations. Adverse shocks trigger additional private information acquisition, exacerbating the lemons problem. The model can account for the business cycle patterns in the U.S., and in particular the sizable fluctuations of capital reallocation.

Capital reallocation from the perspective of endogenous lemons markets and information cycles

Cun (2021) posits information cycles as a new perspective to understand business cycle patterns, and in particular, patterns regarding capital reallocation. In the model of this paper, the degree of information asymmetry on capital quality is endogenously determined and varies with business cycles. The information cycles significantly exacerbate the macroeconomic effects compared to a model where the degree of information asymmetry is constant. This important result provides an alternative explanation for what drives the highly volatile and procyclical nature of capital reallocation. I discuss some qualitative and quantitative implications of this model, as well as potential extensions.

Gasoline demand elasticities in the world’s energy gluttons: a time-varying coefficient approach

In this paper, we estimate the price and income elasticities for gasoline demand in selected energy gluttons-China, India, USA, Russia, and Japan. Specifically, we employ a time-varying parameter approach which adequately deals with potential parameter instabilities and nonlinearities and effectively captures price and income elasticity variations over time, with each time period having its own set of coefficients. Our empirical findings reveal the following: gasoline consumption is price-inelastic and income-inelastic, there are movements in both the price and income elasticities, and the movements generally correspond with business cycle patterns of each of the countries; overall, sensitivity to price and income changes increase during periods of economic crises. Constant elasticity models overestimate price and income elasticities, and income is predominantly more elastic than price. Our conclusion is that policy mechanisms that are price-based such as gasoline taxes are likely to be unsuccessful in achieving consumption-cum-pollution reduction objectives in the energy gluttons. Such policies may, however, be effective if they ensure that gasoline prices rise at a greater rate than income. Such policies may also be useful for revenue-raising purposes.

The Investment Network, Sectoral Comovement, and the Changing U.S. Business Cycle

Abstract We argue that the network of investment production and purchases across sectors is an important propagation mechanism for understanding business cycles. Empirically, we show that the majority of investment goods are produced by a few “investment hubs,” which are more cyclical than other sectors. We embed this investment network into a multisector business cycle model and show that sector-specific shocks to the investment hubs and their key suppliers have large effects on aggregate employment and drive down labor productivity. Quantitatively, we find that sector-specific shocks to hubs and their suppliers account for an increasing share of aggregate fluctuations over time, generating the declining cyclicality of labor productivity and other changes in business cycle patterns since the 1980s.

Economies of scale and international business cycles

This paper incorporates sloping marginal cost curves and their variations across industries into an open macro model, motivated by the fact that industries’ output, imports, and exports are more procyclical when their economies of scale arise from sloping marginal cost curves rather than fixed costs. The model, consistent with the data, delivers endogenous within-firm interdependence across markets and export gains/losses, which reproduce observed industrial business cycle patterns as well as more correlated aggregate business cycles across countries. The findings highlight the importance of marginal cost structures in international business cycle research.

What drives China’s business cycle fluctuations?

In order to identify the causes of China’s new business cycle patterns, such as an obvious downward shift and reduced fluctuations under the ‘New Normal’, this paper develops a large-scale dynamic stochastic general equilibrium model as a unified framework for incorporating technology, investment, trade, economic policy and financial volatility. The main conclusions are as follows. First, as to the causes of the downward shift, the current contraction phase of business cycles is mainly due to narrowing economic policy space, decelerating export growth and higher financial volatility. Secondly, as to the contributors to business cycle fluctuations, export growth deceleration is the main contributor to the current contraction phase of business cycles, while financial volatility is very likely to be a key driver of future business cycle fluctuations. Finally, as to China’s future business cycle patterns, it tends to fluctuate less considering the effects of numerous temporary shocks have emerged so far.

Endogenous Lemons Markets and Information Cycles

I study a dynamic stochastic general equilibrium model in which information on capital quality is asymmetric and the degree of information asymmetry varies endogenously with the state of the economy, amplifying the shocks. Firms hold capital and borrow to cover their operating expenses. Production is subject to idiosyncratic shocks. When a firm's realized revenue is not enough to cover its debt obligation, that firm has to liquidate capital in a market that is subject to the lemons problem. During production, some of the firm's capital depreciates and becomes ``lemon''. Firms initially have no information on which units of their capital have depreciated, but can acquire private information on their own capital at a cost, which allows them to select low-quality capital to sell when liquidation takes place. Private information can be individually beneficial, but creates the lemons problem, which decreases market liquidity and distorts economic allocations. Adverse shocks trigger additional private information acquisition, exacerbating the lemons problem. The model can account for the business cycle patterns in the U.S., and in particular, the sizable fluctuations of capital reallocation.

Late to Recessions: Stocks and the Business Cycle

I find that returns are predictably negative for several months after the onset of recessions, and only become high thereafter. I identify business-cycle turning points by estimating a state-space model using macroeconomic data. Conditioning on the business cycle further reveals that returns exhibit momentum in recessions, whereas in expansions they display the mild reversals expected from discount rate changes. A market timing strategy that optimally exploits this business-cycle pattern produces a 60% increase in the buy-and-hold Sharpe ratio. I find that a subset of hedge funds add value for their clients in part by avoiding stock market crashes during recessions.

Business cycle patterns in European regions

The aim of this paper is threefold. First, we analyze the comovements of business cycles in European regions. Second, we date these business cycles and identify clusters of regions with similar business cycle behavior, using Finite Mixture Markov models. Third, we develop a new index to measure within-country homogeneity. We find that comovement among regions is, on average, quite low, although it increased during the convergence process prior to the euro cash and after the onset of the Great Recession. We identify five different groups of European regions. We also find heterogeneity in the size of border effects.

Business-cycle pattern of asset returns: a general equilibrium explanation

I develop an analytical general-equilibrium model to explain economic sources of business-cycle pattern of aggregate stock market returns. With concave production functions and capital accumulation, a technology shock has a pro-cyclical direct effect and a counter-cyclical indirect effect on expected returns. The indirect effect, reflecting the “feedback” effect of consumers’ behavior on asset returns, dominates the direct effect and causes counter-cyclical variations of expected returns. I show that the conditional mean, volatility, and Sharpe ratios of asset returns all vary counter-cyclically and they are persistent and predictable, and that stock market behavior has forecasting power for real economic activity.

Cyclical and Persistent Carry Trade Returns and Forward Premia

We show that carry trade excess returns and forward premia of exchange rates possess persistent and clear business-cycle patterns. Our results contradict the peso model of hedged carry trade developed by [Burnside, C., M. Eichenbaum, I. Kleshchelski, and S. Rebelo, 2011, Do Peso Problems Explain the Returns to the Carry Trade?, Review of Financial Studies 24(3), 853–891.] and the overconfidence model of carry trade developed by [Burnside, C., B. Han, D. Hirshleifer, and T. Y. Wang, 2011, Investor Overconfidence and the Forward Premium Puzzle, Review of Economic Studies 78(2), 523–558.]. Our results support equilibrium asset pricing models and share the habit formation view of [Verdelhan, A., 2010, A Habit-Based Explanation of the Exchange Rate Risk Premium, Journal of Finance 65(1), 123–145.] that requires countercyclical risk premia. In bad times, when risk aversion is high and domestic interest rates are low, investors require positive currency excess returns. Consistent with [Lustig, H., N. Roussanov, and A. Verdelhan, 2014, Countercyclical Currency Risk Premia, Journal of Financial Economics 111(3), 527–553.] the cyclicality of excess returns is associated with the cyclicality of forward premia. We find that the persistence in forward premia and excess returns is related to their cyclicality. Our results are robust to the [Lustig, H., N. Roussanov, and A. Verdelhan, 2011, Common Risk Factors in Currency Market, Review of Financial Studies 24(11), 3731–3777; Lustig, H., N. Roussanov, and A. Verdelhan, 2014, Countercyclical Currency Risk Premia, Journal of Financial Economics 111(3), 527–553.] high-minus-low (HML) and “dollar carry trade” portfolios.

Financing Asset Sales and Business Cycles*

Using a dynamic model of financing, investment, and macroeconomic risk, we investigate when firms sell assets to fund investments (financing asset sales) across the business cycle. Equity financed investment transfers wealth from equity to debt because asset volatility declines and earnings increase when firms invest. Financing asset sales reduce asset collateral and, hence, transfer wealth back from debt to equity. Exploring the dynamics of the heretofore overlooked “asset sale versus external equity” financing margin across business cycles helps explain novel stylized facts about asset sales and their business cycle patterns that cannot be rationalized by traditional motives for selling assets.

Slow Booms and Deep Busts: 160 Years of Business Cycles in Spain

Abstract This paper introduces an economically important new idea for detrending macroeconomic time series and examines the Spanish business cycle pattern with respect to potential asymmetries. To address difficulties in the trend and cycle decomposition, a nonparametric trend estimation approach is introduced and exemplary applied to the Spanish GDP data for the period 1850 to 2015. The application of an iterative plug-in (IPI) algorithm for endogenous bandwidth selection solves the problem of choosing an adequate smoothing parameter for nonparametric regression. The algorithm identifies continuously Moving Trends (MT) with a time length of 34 years. After we estimate the trend nonparametrically, we fit several time series models to the residuals for further analysis. Although asymmetry during expansion and recession phases is indicated, it is not unambiguous.

Aid Volatility and Real Business Cycles in a Developing Open Economy

This article analyzes the impact of the unpredictability of foreign aid on macroeconomic fluctuations in the recipient country. I build a small open‐economy business cycle model that accounts for foreign aid shocks, with no preference shocks. The model is calibrated to reflect the structural empirical regularities of Cote d'Ivoire, a typical aid‐dependent developing country. The parameters of the exogenous shocks are estimated using Bayesian methods and time series data for Cote d'Ivoire. The model produces business cycle patterns that are consistent with the data and key stylized facts. Specifically, the excess volatility of consumption with respect to output is successfully replicated. The results suggest that the unpredictability of foreign aid contributes to explain the volatility of business cycles in the recipient economy and has negative welfare effects.

What Is the Consumption-CAPM Missing? An Information-Theoretic Framework for the Analysis of Asset Pricing Models

We consider asset pricing models in which the SDF can be factorized into an observable component and a potentially unobservable one. Using a relative entropy minimization approach, we nonparametrically estimate the SDF and its components. Empirically, we find the SDF has a business-cycle pattern and significant correlations with market crashes and the Fama-French factors. Moreover, we derive novel bounds for the SDF that are tighter and have higher information content than existing ones. We show that commonly used consumption-based SDFs correlate poorly with the estimated one, require high risk aversion to satisfy the bounds and understate market crash risk. Received December 19, 2012; editorial decision January 17, 2016 by Editor Pietro Veronesi.

Plant Productivity Dispersion and the College Premium: Evidence from the United States 1977-1997

For the United States in 1987-2014, I document at business cycle frequencies that the high-skill workers’ employer size wage premium is high (low) in times of low (high) unemployment relative to that of the low-skill workers. Specifically, the differential employer size wage premium between high-skill and low-skill workers has an unconditional correlation of -0.4 with the unemployment rate, and varies by about 6 percent over the business cycle. The skill premium itself does not exhibit a clear business cycle pattern over the sample period.

Pricing credit-risky bonds and spread options modelling credit-spread term structures with two-dimensional Markov-modulated jump-diffusion

The relationship between company hazard rates and the business cycle becomes more apparent after a financial crisis. To address this relationship, a regime-switching process with an intensity function is adopted in this paper. In addition, the dynamics of both interest rates and asset values are modelled with a Markov-modulated jump-diffusion model, and a 2-factor hazard rate model is also considered. Based on this more suitable model setting, a closed-form model of pricing risky bonds is derived. The difference in yield between a risky bond and risk-free zero coupon bond is used to model a term structure of credit spreads (CSs) from which a closed-form pricing model of a call option on CSs is obtained. In addition, the degree to which the explicit regime shift affects CSs and credit-risky bond prices is numerically examined using three forward-rate functions under various business-cycle patterns.

Rising BRIC and Changes in Sub‐Saharan Africa's Business Cycle Patterns

AbstractThis paper assesses the extent to which Sub‐Saharan Africa (SSA)'s business cycle is synchronized with that of the rest of the world (RoW). SSA's business cycle has not only moved in the same direction as that of the RoW, but has also gradually drifted away from the G7 in favor of the BRIC. Trade with the BRIC has been the strongest driver of this shift. As fiscal policy stances in SSA and the BRIC are not synchronized, they have not caused output correlation. Also, financial openness, which is at an early stage in SSA, has acted as a neutral force.