Market Exposure and Endogenous Firm Volatility Over the Business Cycle

58 Pages Posted: 2 Apr 2014

See all articles by Ryan Decker

Ryan Decker

University of Maryland

Pablo D'Erasmo

Federal Reserve Bank of Philadelphia - Research Department

Hernan J. Moscoso Boedo

University of Cincinnati

Date Written: March 24, 2014

Abstract

We propose a theory of endogenous firm-level volatility over the business cycle based on endogenous market exposure. Firms that reach a larger number of markets diversify market-specific demand risk at a cost. The model is driven only by total factor productivity shocks and captures the business cycle properties of firm-level volatility. Using a panel of U.S. firms (Compustat), we empirically document the countercyclical nature of firm-level volatility. We then match this panel to Compustat’s Segment data and the U.S. Census’s Longitudinal Business Database (LBD) to show that, consistent with our model, measures of market reach are procyclical, and the countercyclicality of firm-level volatility is driven mostly by those firms that adjust the number of markets to which they are exposed. This finding is explained by the negative elasticity between various measures of market exposure and firm-level idiosyncratic volatility we uncover using Compustat, the LBD, and the Kauffman Firm Survey.

Keywords: Endogenous idiosyncratic risk

JEL Classification: D21, D22, E32, L11, L25

Suggested Citation

Decker, Ryan and D'Erasmo, Pablo and Moscoso Boedo, Hernan J., Market Exposure and Endogenous Firm Volatility Over the Business Cycle (March 24, 2014). FRB of Philadelphia Working Paper No. 14-12, Available at SSRN: https://ssrn.com/abstract=2419032 or http://dx.doi.org/10.2139/ssrn.2419032

Ryan Decker (Contact Author)

University of Maryland ( email )

College Park
College Park, MD 20742
United States

Pablo D'Erasmo

Federal Reserve Bank of Philadelphia - Research Department ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

Hernan J. Moscoso Boedo

University of Cincinnati ( email )

Cincinnati, OH 45221-0389
United States

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