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Financing constraints, irreversibility, and investment dynamics

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  • Caggese, Andrea

Abstract

We develop a structural model of an industry with many entrepreneurial firms in order to investigate the cyclical behaviour of aggregate fixed investment, variable capital investment and output. In particular, we consider an environment in which the entrepreneur cannot borrow unless the debt is secured by collateral and cannot sell fixed capital without liquidating her whole business. We show that, when these entrepreneurs experience persistent idiosyncratic and aggregate shocks, the interplay between financing constraints and irreversibility of fixed capital is essential to explain several common observations. It helps to explain why inventory investment is very volatile and procyclical, especially during recessions, and why the output and inventories of small firms are more volatile and more cyclical than that of large firms. The model is also consistent with the observations that inventory investment leads the business cycle, and that both fixed and inventory investment are sensitive to the net worth of firms, even when marginal productivity of capital is taken into account.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 54 (2007)
Issue (Month): 7 (October)
Pages: 2102-2130

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Handle: RePEc:eee:moneco:v:54:y:2007:i:7:p:2102-2130

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Web page: http://www.elsevier.com/locate/inca/505566

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Citations

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Cited by:
  1. Chatelain, Jean-Bernard & Ralf, Kirsten & Bruno, Amable, 2010. "Patents as Collateral," MPRA Paper 44698, University Library of Munich, Germany.
  2. Alessandra Guariglia & John Tsoukalas & Serafeim Tsoukas, . "Investment, irreversibility, and financing constraints in transition economies," Discussion Papers 10/03, University of Nottingham, School of Economics.
  3. Richard Holt, 2007. "Investment, irreversibility and financial imperfections: the rush to invest and the option to wait," Economics Bulletin, AccessEcon, vol. 5(10), pages 1-10.
  4. Andrea Caggese, 2003. "Testing Financing Constraints on Firm Investment Using Variable Capital," Working Papers 65, Barcelona Graduate School of Economics.
  5. Aubhik Khan & Julia K. Thomas, 2011. "Credit Shocks and Aggregate Fluctuations in an Economy with Production Heterogeneity," NBER Working Papers 17311, National Bureau of Economic Research, Inc.
  6. Rainer Niemann & Caren Sureth, 2011. "The Impact of Differential Capital Income Taxation on the Value of Risky Projects," Economics Bulletin, AccessEcon, vol. 31(2), pages 1047-1054.
  7. Gal, Peter & Pinter, Gabor, 2013. "Capital over the business cycle: renting versus ownership," Bank of England working papers 478, Bank of England.
  8. Björn A. Hauksson, 2005. "Aggregate business fixed investment," Economics wp27_bjorn, Department of Economics, Central bank of Iceland.
  9. Julia K. Thomas & Aubhik Khan, 2009. "Collateral constraints, capital specificity and the distribution of production: the role of real and financial frictions in aggregate fluctuations," 2009 Meeting Papers 1133, Society for Economic Dynamics.
  10. Kaoru Hosono & Masaki Hotei & Chie Umezaki, 2013. "External Finance Constraints and the Timing of Investment Spikes," Public Policy Review, Policy Research Institute, Ministry of Finance Japan, vol. 9(2), pages 365-404, March.
  11. McGee, M. Kevin, 2010. "Twice constrained investment under uncertainty: A mixed time model," Research in Economics, Elsevier, vol. 64(2), pages 110-120, June.
  12. Simona Mateut & Paul Mizen & Ydriss Ziane, . "No Going Back: How the Production Process Affects Access to Short-term Credit," Discussion Papers 12/14, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM).
  13. Julia Thomas & Aubhik Khan, 2012. "Uncertainty Shocks in an Economy with Collateral Constraints," 2012 Meeting Papers 1075, Society for Economic Dynamics.

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