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Essays on the Real Effects of Financial Market Fluctuations


In the following essays I study the effects of disruptions in financial markets on aggregate outcomes.

In the first two chapters, I study the transmission mechanisms from financial crises to the real economy in emerging countries, in environments where firms set heterogeneous markups. The introduction of heterogeneous markups is backed by data: I document that there is evidence of firms setting heterogeneous markups using microdata for Argentina and Colombia. As an endogenous source of resource misallocation across firms, markups can potentially be an important driver of aggregate productivity and output dynamics during large financial crises.

The opening chapter is my first attempt to address the role of heterogeneous markups during financial crises. To investigate the extent to which this has a significant quantitative role, I adapt a model of imperfect competition where markups are a function of within-sector market shares. Using microdata from Argentina's annual manufacturing survey, I document that market shares become more disperse during the Argentine 2001-02 crisis. Through the lens of the model this results in increased variability of markups, which decreases aggregate productivity. I perform an accounting exercise and find that markup-induced misallocation can explain between 6.4$\%$ and 15.6$\%$ of the fall in aggregate productivity during the Argentine crisis, or up to one third of the overall effect of resource misallocation.

In Chapter 2, joint with Gabriel Zaourak, we explicitly introduce financial frictions to analyze the interaction between credit constraints and variable markups during a credit crunch. Financial frictions take the form of a collateral constraint on working capital. A financial crisis in this framework is modeled as an exogenous shock to the maximum amount of working capital that can be financed externally. Using microdata from financial statements and manufacturing surveys, we calibrate the model to match salient features of the Colombian economy for the 1998-99 financial crisis, and evaluate the transition dynamics of aggregate variables. The model replicates the fall and subsequent recovery of aggregate output and productivity, as well as the concentration patterns observed in the data. We find that in this case variable markups partially offset the resource misallocation triggered by a credit crunch, dampening the response of aggregate variables. The reason is that under variable markups firms try not to change their price (hence quantities) as much as they would under constant markups. This is an example of the ambiguous effect of distortions in a second best world.

The last chapter is an early empirical exploration of the link between price fluctuations in financial markets and aggregate labor market outcomes, using data from the United Kingdom. I build a quarterly wealth index from stock market prices and real estate prices for the 1971-2012 period. Using a VECM, I find a robust co-integrating relationship between the unemployment rate and the wealth index. Specifically, fluctuations in wealth Granger-cause the unemployment rate, but not the opposite. This relationship is true for both components of the wealth index individually, and is stable over time. This is consistent with a model where output is demand determined and fluctuations in asset prices affect the unemployment rate through changes in aggregate consumption.

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