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. 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.

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:

Endogenizing the Default Rate II rere rfrf ψ

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.