This paper studies the impact of financial sector size and leverage on business cycles and risk-free rates dynamics. We … model a general equilibrium productive economy where financial intermediaries provide costly risk mitigation to households … intermediaries' relative size, but may also mitigate the business cycle. Moreover, it makes risk-free rates pro-cyclical. Households …

regime switching model with a state-dependent cash flow process to capture macroeconomic risk in a firm's cash flow. Our … ratios, benefits to leverage, and costs of operating at a non-optimal leverage. If macroeconomic risk decreases, i … risk. The regime switching property of EBIT traces observed EBIT paths closely and is applicable to a wide range of …