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Firm Investment in Imperfect Capital Markets: A Structural Estimation

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Author Info
Sangeeta Pratap (ITAM)
Silvio Rendon (University of Western Ontario)

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Abstract

In this paper we characterize and estimate the degree to which liquidity constraints affect real activity. We set up a dynamic model of firm investment and debt in which liquidity constraints enter explicitly into the firm's maximization problem, so that investment depends positively on the firm's financial position. The optimal policy rules are incorporated into a maximum likelihood procedure to estimate the structural parameters of the model. We identify liquidity constraints from the dynamics of a firm's evolution, as formalized by the dynamic estimation process, and find that they significantly affect investment decisions of firms. Firms ability to raise equity is about 73% of what it would have been under free capital markets. If firms can finance investment by issuing fresh equity, rather than with internal funds or debt, average capital stock is about 6% higher over a period of 20 years. Transitory interest rate shocks have a sustained impact on capital accumulation, which lasts for several periods. (Copyright: Elsevier)

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File URL: http://dx.doi.org/10.1016/S1094-2025(03)00019-X
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Publisher Info
Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 6 (2003)
Issue (Month): 3 (July)
Pages: 513-545
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Handle: RePEc:red:issued:v:6:y:2003:i:3:p:513-545

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Related research
Keywords: Investment Liquidity constraints Estimation of dynamic structural models Financial accelerator

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Find related papers by JEL classification:
C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
E22 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Capital; Investment; Capacity
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Investment Policy

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Sangeeta Pratap & Carlos Urrutia, 2004. "Firm Dynamics, Investment, and Debt Portfolio: Balance Sheet Effects of the Mexican Crisis of 1994," Working Papers 0406, Centro de Investigacion Economica, ITAM. [Downloadable!]
    Other versions:
  2. Sangeeta Pratap, 2000. "Do Adjustment Costs Explain Investment-Cash Flow Insensitivity?," Computing in Economics and Finance 2000 315, Society for Computational Economics. [Downloadable!]
    Other versions:
  3. Sangeeta Pratap & Silvio Rendon, 2003. "Firm Investment in Imperfect Capital Markets: A Structural Estimation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(3), pages 513-545, July. [Downloadable!] (restricted)
    Other versions:
  4. Alexander Cobham, . "Making Bad Decisions: firm size and investment under uncertainty," QEH Working Papers qehwps39, Queen Elizabeth House, University of Oxford. [Downloadable!]
  5. Covas, Francisco & Den Haan, Wouter, 2007. "The Role of Debt and Equity Finance over the Business Cycle," CEPR Discussion Papers 6145, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  6. Simon Gilchrist & Charles Himmelberg, 1998. "Investment, Fundamentals and Finance," NBER Working Papers 6652, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  7. Silvio Rendón, 2001. "Job Creation under Liquidity Constraints: the Spanish Case," Banco de España Working Papers 0101, Banco de España. [Downloadable!]
    Other versions:
  8. James S. Costain, 1998. "A Simple Model of Multiple Equilibria Based on Risk," Economics Working Papers 407, Department of Economics and Business, Universitat Pompeu Fabra, revised Jul 1999. [Downloadable!]
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