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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)

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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Bibliographic 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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References

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Citations

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Cited by:
  1. Francisco Covas & Wouter Denhaan, 2006. "The role of debt and equity finance over the business cycle," 2006 Meeting Papers 407, Society for Economic Dynamics.
  2. Addessi, William & Saltari, Enrico, 2011. "The effect of debt tax benefits on firm investment decisions," MPRA Paper 35436, University Library of Munich, Germany.
  3. 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.
  4. Sangeeta Pratap, 2000. "Do Adjustment Costs Explain Investment-Cash Flow Insensitivity?," Computing in Economics and Finance 2000 315, Society for Computational Economics.
  5. 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.
  6. Fernández, Raquel, 1998. "Education and Borrowing Constraints: Tests Vs. Prices," CEPR Discussion Papers 1913, C.E.P.R. Discussion Papers.
  7. Alexander Cobham, . "Making Bad Decisions: firm size and investment under uncertainty," QEH Working Papers qehwps39, Queen Elizabeth House, University of Oxford.
  8. Simon Gilchrist & Charles Himmelberg, 1998. "Investment, Fundamentals and Finance," NBER Working Papers 6652, National Bureau of Economic Research, Inc.
  9. Silvio Rendón, 2001. "Job Creation under Liquidity Constraints: the Spanish Case," Banco de España Working Papers 0101, Banco de España.
  10. 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.

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