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Firm Investment and Financial Frictions

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Author Info
Christopher F. Baum
Mustafa Caglayan
Oleksandr Talavera

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Abstract

In this paper we investigate the analytical and empirical linkages between firms' capital investment behavior and financial frictions arising from asymmetric information, proxied by firms' liquidity and degree of uncertainty. Measures of intrinsic and extrinsic uncertainty are derived from firms' daily stock returns and S&P 500 index returns along with a CAPM-based risk measure. We employ a panel of U.S. manufacturing firm data obtained from COMPUSTAT over the 1984-2003 period. Financial frictions captured by interactions between firms' cash flow and both intrinsic and CAPM-based measures of uncertainty have a significant negative impact on firms' investment spending, while extrinsic uncertainty has a positive impact.

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Paper provided by DIW Berlin, German Institute for Economic Research in its series Discussion Papers of DIW Berlin with number 634.

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Length: 24 p.
Date of creation: 2006
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Handle: RePEc:diw:diwwpp:dp634

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Related research
Keywords: capital investment asymmetric information financial frictions uncertainty CAPM

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Find related papers by JEL classification:
E22 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Capital; Investment; Capacity
D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data

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