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Financial Markets, Banks' Cost of Funding, and Firms' Real Decisions: Lessons from Two Crises

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Author Info

  • Pierluigi Balduzzi

    (Boston College)

  • Emanuele Brancati

    (University of Rome, Tor Vergata)

  • Fabio Schiantarelli

    ()
    (Boston College
    IZA)

Abstract

We test whether financial market conditions affect firms' decisions through their impact on the level and volatility of banks' cost of funding. We investigate this transmission channel using data on Italian banks and firms during the 2006–2011 period. We use banks' CDS spreads and Tobin's Qs to proxy for their cost of funding. Italian banks experienced two large shocks that lead to heterogeneous variation in their cost of funding: the 2007–2009 financial crisis and the 2010–2012 sovereign debt crisis. The Italian case is particularly interesting because Italian firms are predominantly small and privately held, and rely heavily on bank debt. Hence, most Italian firms are unable to cushion negative shocks to bank credit by resorting to capital markets. In investigating this issue, we take advantage of a newly available data set covering a representative sample of over 3,000 firms and containing information on the identity of the bank(s) each firm has a relationship with. We find robust evidence that an increase in Italian banks' CDS spreads and a decrease in their Tobin's Q leads younger and smaller firms to invest, hire, and borrow less. We conclude that financial market conditions impact even privately held firms, and that the banks' cost of funding is an important channel through which these effects are transmitted.

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Bibliographic Info

Paper provided by Boston College Department of Economics in its series Boston College Working Papers in Economics with number 824.

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Date of creation: 01 Jul 2013
Date of revision: 29 Apr 2014
Handle: RePEc:boc:bocoec:824

Note: previously circulated as "Banks' Market Valuations and Firms' Decisions: Lessons from Two Crises"
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Keywords: Financial market shocks; banks; credit-default swaps; volatility; investment; employment; lending;

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