July 2026

Demand Shocks and Endogenous Uncertainty

Diego Vilán

Abstract:

This study examines how fluctuations in firm-level uncertainty arise over the business cycle and how they influence aggregate economic activity. To do so, it develops a general equilibrium incomplete-markets model in which heterogeneous, risk-averse firms face idiosyncratic demand uncertainty and aggregate shocks to consumer credit conditions. A change in aggregate credit affects not only the expected level of firm demand, but also the cross-sectional dispersion of sales per worker by shifting the probability that firms operate at capacity. Thus, first-moment shocks give rise to endogenous second-moment effects. The model is disciplined using U.S. Compustat data on firm sales and employment and proprietary customer traffic data. The calibrated economy reproduces key cross-sectional moments and business-cycle comovements, including countercyclical dispersion in firm outcomes. Quantitatively, endogenous uncertainty accounts for roughly one quarter of the output response and one third of the employment response to aggregate credit shocks. The results suggest that uncertainty is not only an independent source of aggregate fluctuations, but also an endogenous propagation mechanism through which changes in demand conditions amplify business cycles.

Keywords: Uncertainty, Heterogeneous Firms, Cross-sectional firm dynamics.

DOI: https://doi.org/10.17016/FEDS.2026.050

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