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Financial Structure and Macroeconomic Volatility: Theory and Evidence

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  • Huizinga, Harry
  • Zhu, Dantao

Abstract

This paper presents a simple model capturing differences between debt and equity finance to examine how financial structure matters for macroeconomic volatility. Debt finance is relatively cheap in the sense that debt holders need to verify relatively few profitability states, but debt finance may lead to costly bankruptcy. At the aggregate level, a more debt-based financial structure leads to a higher bankruptcy rate. Therefore, aggregate output is more variable in case of a heavy reliance on debt finance. This paper provides empirical evidence that countries with more equity finance have a lower variance of GDP and a lower probability of episodes of negative economic growth.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5697.

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Date of creation: Jun 2006
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Handle: RePEc:cpr:ceprdp:5697

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Keywords: bankruptcy costs; financial structure; macroeconomic volatility;

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