Template-Type: ReDIF-Paper 1.0

Author-Name: François Gourio
Author-X-Name-First: François 
Author-X-Name-Last: Gourio
Author-Email: fgourio@bu.edu
Author-Workplace-Name: Department of Economics, Boston University

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Author-X-Name-Last: 
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Title: Firms’ Heterogeneous Sensitivities to the Business Cycle,
and the
Cross-Section of Expected Returns

Abstract: In this paper, I propose and test a simple technology-based theory of firms’ sensitivities
to aggregate shocks. I show that when the elasticity of substitution between capital and
labor is below unity, low profitability firms are more sensitive to aggregate shocks, i.e. to the
business cycle. Since the wage is smoother than productivity, revenues are more procyclical
than costs, making profits, the residual procyclical. Firms with low profitability are more
procyclical since the residual is smaller and the amplification greater. I study the asset
pricing implications of this technology and find that it can explain the riskiness of small and
“value” firms (Fama and French 1996). These firms are less profitable and are thus more
procyclical. I find empirically that the cross-section of expected returns is well explained by
differences in sensitivities of firms’ earnings to GDP growth, or by differences in profitability.
The model yields rich empirical implications by linking a firm’s real behavior (the elasticity
of output, employment and profits to an aggregate shock) to its financial characteristics (the
firm’s betas and its average return). I next embed my partial equilibrium model in a full
DSGE model to conduct a GE analysis. Empirically I show that firms with low margins are
indeed more sensitive to the business cycle in their employment, sales or profits.

Length:  52 pages
Creation-Date: 2006-02
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File-URL: http://people.bu.edu/fgourio/xspaper.pdf
File-Format: Application/pdf
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Number: WP2006-005
Classification-JEL: E44, G12
Keywords: Cross-Section of Returns, Book-to-Market, Value Premium, Productivity
Heterogeneity.
Handle: RePEc:bos:wpaper:WP2006-005