Financial Innovations and Macroeconomic Volatility
(with Urban Jermann)

The volatility of U.S. business cycles has declined in the last two decades. In this paper we document that, contrary to this, during the same period firms' financial flows have become more volatile. We develop a model with explicit roles for debt and equity financing, and we investigate the importance of financial innovations. We find that innovations allowing for a more flexible use of equity financing can account for a substantial reduction in macroeconomic volatility together with the higher volatility in the financial structure of firms.