Skewness and Time-Varying Second Moments in a Nonlinear Production Network: Theory and Evidence

This paper studies asymmetry in economic activity over the business cycle. It develops a tractable multisector model of the economy in which complementarity across inputs causes aggregate activity to be left skewed with countercyclical volatility. We then examine implications of the model regarding the time-series skewness of activity at the sectoral level, cyclicality of dispersion and skewness across sectors, and the conditional covariances of sector growth rates, finding support for each in the data. In the data, the skewness of employment growth, industrial production growth, and stock returns increases with the level of aggregation, which is consistent with the model’s implication that it is the nonlinearity in the production structure of the economy that generates the skewness. Other prominent models of asymmetry are not able to simultaneously match the range of empirical facts that the production network model can. *Dew-Becker: Northwestern University and NBER, Email: i-dewbecker@kellogg.northwestern.edu; Tahbaz-Salehi: Northwestern University and CEPR, Email: alirezat@kellogg.northwestern.edu; Vedolin: Boston University, NBER, and CEPR, Email: avedolin@bu.edu. We appreciate helpful comments from seminar participants at the NBER Monetary Program and Wharton.