Aggregate Risk in Economics
Aggregate risk can be generated by a variety of sources. Fiscal, monetary, and regulatory policy can all be sources of aggregate risk. In some cases, shocks from phenomena like weather and natural disaster can pose aggregate risks. Small economies can also be subject to aggregate risks generated by international conditions such as terms of trade shocks.
Aggregate risk has potentially large implications for economic growth. For example, in the presence of credit rationing, aggregate risk can cause bank failures and hinder capital accumulation. Banks may respond to increases in profitability-threatening aggregate risk by raising standards for quality and quantity credit rationing to reduce monitoring costs; but the practice of lending to small numbers of borrowers reduces the diversification of bank portfolios (concentration risk) while also denying credit to some potentially productive firms or industries. As a result, capital accumulation and the overall productivity level of the economy can decline.
In economic modeling, model outcomes depend heavily on the nature of risk. Modelers often incorporate aggregate risk through shocks to endowments (budget constraints), productivity, monetary policy, or external factors like terms of trade. Idiosyncratic risks can be introduced through mechanisms like individual labor productivity shocks; if agents possess the ability to trade assets and lack borrowing constraints, the welfare effects of idiosyncratic risks are minor. The welfare costs of aggregate risk, though, can be significant.
Under some conditions, aggregate risk can arise from the aggregation of micro shocks to individual agents. This can be the case in models with many agents and strategic complementarities; situations with such characteristics include: innovation, search and trading, production in the presence of input complementarities, and information sharing. Such situations can generate aggregate data which are empirically indistinguishable from a data-generating process with aggregate shocks.
Read more about this topic: Systematic Risk
Famous quotes containing the words aggregate, risk and/or economics:
“We think of religion as the symbolic expression of our highest moral ideals; we think of magic as a crude aggregate of superstitions. Religious belief seems to become mere superstitious credulity if we admit any relationship with magic. On the other hand our anthropological and ethnographical material makes it extremely difficult to separate the two fields.”
—Ernst Cassirer (1874–1945)
“If you love the good thing vitally, enough to give up for it all that one must give up, then you must hate the cheap thing just as hard. I tell you, there is such a thing as creative hate! A contempt that drives you through fire, makes you risk everything and lose everything, makes you a long sight better than you ever knew you could be.”
—Willa Cather (1873–1947)
“The new sound-sphere is global. It ripples at great speed across languages, ideologies, frontiers and races.... The economics of this musical esperanto is staggering. Rock and pop breed concentric worlds of fashion, setting and life-style. Popular music has brought with it sociologies of private and public manner, of group solidarity. The politics of Eden come loud.”
—George Steiner (b. 1929)