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Financial Risk and Unemployment by Eckstein, Setty and Weiss

Financial Risk and Unemployment by Eckstein, Setty and Weiss. Joseph Zeira Hebrew University of Jerusalem Mishkenot Shaananim 20/6/2014. A Brief Summary. The paper studies the effect of financial shocks on unemployment through the model of search in the labor market.

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Financial Risk and Unemployment by Eckstein, Setty and Weiss

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  1. Financial Risk and Unemploymentby Eckstein, Setty and Weiss Joseph Zeira Hebrew University of Jerusalem Mishkenot Shaananim 20/6/2014

  2. A Brief Summary • The paper studies the effect of financial shocks on unemployment through the model of search in the labor market. • Financial shocks are modeled as shocks to the borrowers interest rate, which are assumed to be exogenous. • These shocks affect output through reduction of profit, through increasing the separation rate σ and through the bankruptcy rate ψ. • The paper simulates these effects in a calibrated model.

  3. Endogenizing the Default Rate I • The default rate affects on the spread between the lending and borrowing rates. • But it also depends on the borrowing rate. Profits are negative when: • Hence, if productivity p is stochastic across firms (but average fixed) this condition determines the probability of default:

  4. Endogenizing the Default Rate II ψ re rf

  5. Imperfect Capital Markets • The paper mentions additional elements in the spread, but assumes that they are a fixed proportion of the risk. • This reduces the ability to assign importance to such factors. • These were studied extensively in the literature on imperfect capital markets and business cycles. • Adding a cost of financial intermediation, that is independent, could have an independent and exogenous effect on the spread and makes the model more fit to describe the effects a a financial crisis and of a credit crunch.

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