Conference Agenda

We study sources and implications of undiversified portfolios in a production-based asset pricing model with financial frictions. Households take concentrated positions in a single firm exposed to idiosyncratic shocks because managerial effort requires equity stakes, and because investors gain private benefits from concentrated holdings. Matching data on returns and portfolios, we find that the marginal investor optimally holds 45% of their portfolio in a single firm, incentivizing managerial effort that accounts for 4% of aggregate output. Investors derive control benefits equivalent to 3% points of excess return, rationalizing low observed returns on undiversified holdings in the data. A counterfactual world of full diversification would feature higher risk free rates, lower risk premiums on fully diversified and concentrated assets, less capital accumulation, yet higher consumption and welfare. Exposure to undiversified firm risk can explain approximately 40% of the level and 20% of the volatility of the equity premium. A targeted subsidy that decreases diversification improves welfare by increasing managerial effort and reducing financial frictions.

Young firms' contribution to aggregate employment has been underwhelming. However, we show that a similar trend is not apparent in their contribution to aggregate sales or stock-market capitalization, suggesting that these firms have exhibited a high ratio of average-to-marginal revenue-product-of-labor. We study the implications of the arrival of such firms in a standard model of dynamic firm heterogeneity, and show that their arrival provides a unified explanation for a large number of facts related to the decline in ``business dynamism''. We provide an analytical framework to gauge the quantitative impact of the decline in business dynamism on aggregate economic activity.

Business cycles are typically associated with lower firm cashflows and higher discount rates. We show that these two components have very different implications for labor income growth. Higher discount rates lead to lower worker earnings for workers at the bottom of the income distribution; these declines are primarily driven by job separations. By contrast, lower cashflow (or productivity) news is followed by declines in earnings for workers in the top of the income distribution, with most of the effect coming from the intensive margin. We build an equilibrium model of labor market search that quantitatively replicates these facts. The model has several implications regarding the role of discount rates in generating unemployment fluctuations; the drivers of the low level of cyclicality of aggregate worker earnings; and the redistributive effects of business cycle fluctuations and monetary policy. These implications are consistent with the data.