‘Wait-and-See’ business cycles?

Abstract

Are shocks to firms' profitability risk, propagated by physical capital adjustment costs, a major source of business cycle fluctuations? This paper studies this question using a heterogeneous-firm dynamic stochastic general equilibrium model, where firms face fixed capital adjustment costs. Surprise increases in idiosyncratic risk lead firms to adopt a ‘wait-and-see’ policy for investment. The model is calibrated using a German firm-level data set with broader coverage than comparable U.S. data sets. The main result is that time-varying firm-level risk through ‘wait-and-see’ dynamics is unlikely a major source of business cycle fluctuations.