The Aggregate Costs of Uninsurable Business Risk

We use firm-level data to document that private businesses experience large fluctuations in their profit shares. These are due to large, fat-tailed, and transitory changes in output that are not fully accompanied by changes in their inputs. We interpret this evidence using a model of entrepreneurial dynamics. Because firms can limit their exposure to risk by operating at a smaller scale, our model predicts large macroeconomic losses from uninsurable business risk,much larger than those stemming from credit constraints. While self-financing allows entrepreneurs to quickly overcome credit constraints, even wealthy entrepreneurs remain considerably exposed to risk.