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Financial distress, bankruptcy law and the business cycle

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Author Info

  • Javier Suarez

    ()

  • Oren Sussman

    ()

Abstract

This paper explores the business cycle implications of financial distress and bankruptcy law. We find that due to the presence of financial imperfections the effect of liquidations on the price of capital goods can generate endogenous fluctuations. We show that a law reform that ‘softens’ bankruptcy law may increase the amplitude of the cycle in the long run. In contrast, a policy of bailing out businesses during the bust, or actively managing the interest rate across the cycle, could stabilize the economy in the long run. A comprehensive welfare analysis of the policy is provided as well.

(This abstract was borrowed from another version of this item.)

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File URL: http://hdl.handle.net/10.1007/s10436-006-0056-9
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Bibliographic Info

Article provided by Springer in its journal Annals of Finance.

Volume (Year): 3 (2007)
Issue (Month): 1 (January)
Pages: 5-35

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Handle: RePEc:kap:annfin:v:3:y:2007:i:1:p:5-35

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Web page: http://www.springerlink.com/link.asp?id=112370

Related research

Keywords: Bankruptcy law; Business cycles; Financial distress; Liquidation; E32; E44; G33;

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References

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  1. Oliver Hart & John Moore, 1997. "Default and Renegotiation: A Dynamic Model of Debt," NBER Working Papers 5907, National Bureau of Economic Research, Inc.
  2. Berkovitch, Elazar & Israel, Ronen & Zender, Jaime F., 1997. "Optimal bankruptcy law and firm-specific investments," European Economic Review, Elsevier, vol. 41(3-5), pages 487-497, April.
  3. Suarez, Javier & Sussman, Oren, 1997. "Endogenous Cycles in a Stiglitz-Weiss Economy," Journal of Economic Theory, Elsevier, vol. 76(1), pages 47-71, September.
  4. Julian R. Franks & Kjell G. Nyborg & Walter N. Torous, 1996. "A Comparison of UK, US and German Insolvency Codes," Financial Management, Financial Management Association, vol. 25(3), Fall.
  5. Bolton, Patrick & Scharfstein, David S, 1996. "Optimal Debt Structure and the Number of Creditors," Journal of Political Economy, University of Chicago Press, vol. 104(1), pages 1-25, February.
  6. Shleifer, Andrei & Vishny, Robert W, 1992. " Liquidation Values and Debt Capacity: A Market Equilibrium Approach," Journal of Finance, American Finance Association, vol. 47(4), pages 1343-66, September.
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Citations

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Cited by:
  1. Eric Tymoigne, 2010. "Detecting Ponzi Finance: An Evolutionary Approach to the Measure of Financial Fragility," Economics Working Paper Archive wp_605, Levy Economics Institute.
  2. Guembel, Alexander & Sussman, Oren, 2010. "Liquidity, Contagion and Financial Crisis," IDEI Working Papers 664, Institut d'Économie Industrielle (IDEI), Toulouse.
  3. Carl Chiarella & Corrado Di Guilmi, 2010. "The Financial Instability Hypothesis:a Stochastic Microfoundation Framework," Research Paper Series 273, Quantitative Finance Research Centre, University of Technology, Sydney.
  4. Korkeamaki, Timo & Koskinen, Yrjo & Takalo, Tuomas, 2007. "Phoenix rising: Legal reforms and changes in valuations in Finland during the economic crisis," Journal of Financial Stability, Elsevier, vol. 3(1), pages 33-58, April.
  5. Charles Goodhart & Dimitrios Tsomocos, 2007. "Financial stability: theory and applications," Annals of Finance, Springer, vol. 3(1), pages 1-4, January.
  6. Ilhyock Shim & Goetz von Peter, 2007. "Distress selling and asset market feedback," BIS Working Papers 229, Bank for International Settlements.
  7. Chiarella Carl & Di Guilmi Corrado, 2012. "The Fiscal Cost of Financial Instability," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 16(4), pages 1-29, October.

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