We extend the Carlstrom and Fuerst (American Economic Review, 1997, 87, pp. 893-910) agency cost model of business cycles by including time-varying uncertainty in the technology shocks that affect capital production. We first demonstrate that standard linearization methods can be used to solve the model yet second moments enter the economy's equilibrium policy functions. We then demonstrate that an increase in uncertainty causes, ceteris paribus, a fall in investment supply. We also show that persistence of uncertainty affects both quantitatively and qualitatively the behaviour of the economy.

A consistent empirical feature of bond yields is that term premia are, on average, positive. The majority of theoretical explanations for this observation have viewed the term premia through the lens of the consumption based capital asset pricing model. In contrast, we harken to an older empirical literature that attributes the term premium to the idea that short maturity bonds are inherently more liquid. The goal of this paper is to provide a theoretical justification of this concept. To that end, we employ a monetary‐search model extended to include assets of different maturities. Short term assets mature in time to take advantage of random consumption opportunities. Long term assets cannot be used directly to purchase consumption, but agents may liquidate them in a secondary asset market characterized by search and bargaining frictions. Our model delivers three results that are consistent with empirical facts. First, long term assets have higher rates of return in steady state to compensate agents for their relative lack of liquidity. Second, since the difference in the yield of short and long term assets reflects asset market frictions, our model predicts a steeper yield curve for assets that trade in less liquid secondary markets. Third, our model predicts that freshly issued (“on‐the‐run”) assets will sell at higher prices than previously issued (“off‐the‐run”) assets that mature in nearby dates, because sellers of the latter have a more urgent need for liquidity.

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a b s t r a c tThis paper analyzes the role of stochastic uncertainty in a multi-sector housing model with financial frictions. We include time varying uncertainty (i.e. risk shocks) in the technology shocks that affect housing production and provide estimates of the time-series properties of risk shocks by using firm level productivity data. The analysis demonstrates that risk shocks to the housing production sector are a quantitatively important impulse mechanism for understanding housing price movements. Specifically, the model can match the volatility of housing prices observed in the data. It is also demonstrated that adjustment costs are important in replicating the contemporaneous correlation of housing prices with GDP and residential investment. Critically, bankruptcy costs act as an endogenous markup factor in housing prices and are an important determinant of house price volatility. However, in comparison to housing demand shocks, risk shocks have low explanatory power for real quantities.

Purpose -The purpose of this paper is to analyze the credit channel effects on investment behavior for the US and the Euro area. Design/methodology/approach -This paper uses the dynamic stochastic general equilibrium model and calibrates a version of the Carlstrom and Fuerst's (1997) agency cost model of business cycles with timevarying uncertainty in the technology shocks that affect capital production. To highlight the differences between the US and European financial sectors, the paper focuses on two key components of the lending channel: the risk premium associated with bank loans and the bankruptcy rates.Findings -This paper shows that the effects of minor differences in the credit market translate into large, persistent and asymmetric fluctuations in real and financial variables and depend on the type of shocks. The results imply that the Euro areas supply elasticities for capital are less elastic than that of the USA following a technology shock. Finally, the authors find that the adverse impact of uncertainty shocks is heterogeneous across countries and amplified by the steady-state bankruptcy rate and risk premium. Originality/value -This paper quantifies the effects of uncertainty shocks when there is a credit channel due to asymmetric information between lenders and borrowers for the Euro area countries, and then compares the results to that of the USA. This paper shows that financial accelerator mechanism could potentially play a significant role in business cycles in the Euro area. This result directly lends one to conclude the following: the credit channel that affects the financial sector does indeed matter for macroeconomic behavior, and that policy makers should be attentive in smoothing out uncertainties if the economic policies are to lower the business and financial cycle volatilities.