On Aggregate Fluctuations, Systemic Risk, and the Covariance of Firm-Level Activity
Abstract: Pairwise covariances of firm growth rates appear to drive the variance of aggregate growth rates in productivity, sales, and profit for public firms in the United States over the last half-century. High-productivity firms contribute most to the covariances driving aggregate variance, but least per dollar of market value that they generate. This fact may explain why investors demand lower returns from high-productivity firms. A tractable model of within-firm diversification qualitatively matches the empirical evidence, generating endogenous first and second moments of firm and aggregate productivity, and endogenous comovement between firm and aggregate productivity. In the model, movements in firm productivity drive movements in firm sales and profit, and firms' expected excess stock returns rise as firms' productivities covary more with aggregate productivity, relative to their market values. A regression analysis lends tentative empirical support to several predictions of the model.
Figure: The Technology Choice Problem of Firm ω
Notes. The figure illustrates the technology choice problem for firm ω. The vertical axis measures costs and benefits associated with firm ω's operation of different technologies. The horizontal axis represents the set of available technologies, arranged left to right from least to most expensive in terms of fixed costs. The horizontal expected discounted gross profit curve represents firm ω's expected benefit from operating the available technologies. The upward-sloping fixed cost curve represents the fixed cost associated with each technology. Firm ω's technology set is determined by the intersection of the expected gross profit curve and the fixed cost curve at point v̄(ω). The firm can profitably produce only with technologies to the left of this point.
BibTeX Citation
@article{Mullen2025AggregateFluctuations,
title={On Aggregate Fluctuations, Systemic Risk, and the Covariance of Firm-Level Activity},
author={Rory Mullen},
journal={Working Paper},
year={2025}
}