| Summary: | This dissertation examines the quantitative importance of firm-specific shocks on aggregate volatility. Firm-specific shocks to the largest firms can directly contribute to aggregate fluctuations whenever the firm size distribution is fat-tailed giving rise to the granular hypothesis. The first section of this dissertation identifies the variation in U.S. aggregate sales that can be explained by firm-level idiosyncratic shocks on the one hand and macro-sectoral forces on the other. By using a novel, comprehensive data set compiled from administrative sources that contains the universe of firms and trade transactions, I find that the granular hypothesis accounts at most for 16 percent of the variation in aggregate sales growth. This is about half of that found by previous studies that imposed Gibrat's law where all firms are equally volatile regardless of their size.
The second section focuses on the underlying reason for the apparent discrepancy between the results found in this dissertation and the previous literature. I argue that the relatively small role of granularity in the U.S. economy can be entirely rationalized by accounting for the negative power law relationship between firm-level volatility and size, i.e. the size-variance relationship. Using the full distribution of growth rates among U.S. firms, I find robust evidence of such a relationship between firm-level volatility and size. The largest firms, whose shocks are most prominent for the granular channel, are the least volatile under the size-variance relationship, thus their influence on aggregates is mitigated. I show that by taking this relationship into account the effect of firm-specific shocks on observed macroeconomic volatility is substantially reduced.
The last part of this dissertation investigates several plausible mechanisms that could explain the negative size-variance relationship. After empirically ruling out some of them, I suggest a "market power" channel in which large firms face smaller price elasticities and therefore respond less to a given-sized productivity shock than small firms do. I provide direct evidence for this mechanism by estimating demand elasticities among U.S. manufactures. Furthermore, this channel is consistent with the observation that markups are increasing in size. The results of a structural estimation procedure indicate that this is indeed the case for U.S. manufactures. Lastly, these robust empirical findings can be rationalized in an analytically tractable framework featuring random growth and a Kimball demand aggregator.
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