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Financing Constraints, Irreversibility, and Investment Dynamics

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  • Andrea Caggese

Abstract

We develop a structural model of an industry with many entrepreneurial firms in order to investigate the cyclical behaviour of aggregate fixed investment, variable capital investment and output. In particular, we consider an environment in which the entrepreneur cannot borrow unless the debt is secured by collateral and cannot sell fixed capital without liquidating her whole business. We show that, when these entrepreneurs experience persistent idiosyncratic and aggregate shocks, the inter-play between financing constraints and irreversibility of fixed capital is essential to explain several common observations. It helps to explain why inventory investment is very volatile and procyclical, especially during recessions, and why the output and inventories of small firms are more volatile and more cyclical than that of large firms. The model is also consistent with the observations that inventory investment leads the business cycle, and that both fixed and inventory investment are sensitive to the net worth of firms, even when marginal productivity of capital is taken into account.

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Bibliographic Info

Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp440.

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Date of creation: Mar 2003
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Handle: RePEc:fmg:fmgdps:dp440

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Citations

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Cited by:
  1. McGee, M. Kevin, 2010. "Twice constrained investment under uncertainty: A mixed time model," Research in Economics, Elsevier, vol. 64(2), pages 110-120, June.
  2. Aubhik Khan & Julia K. Thomas, 2013. "Credit Shocks and Aggregate Fluctuations in an Economy with Production Heterogeneity," Journal of Political Economy, University of Chicago Press, vol. 121(6), pages 1055 - 1107.
  3. Chatelain, Jean-Bernard & Ralf, Kirsten & Bruno, Amable, 2010. "Patents as Collateral," MPRA Paper 44698, University Library of Munich, Germany.
  4. Kaoru Hosono & Masaki Hotei & Chie Umezaki, 2013. "External Finance Constraints and the Timing of Investment Spikes," Public Policy Review, Policy Research Institute, Ministry of Finance Japan, vol. 9(2), pages 365-404, March.
  5. Caggese, Andrea, 2007. "Testing financing constraints on firm investment using variable capital," Journal of Financial Economics, Elsevier, vol. 86(3), pages 683-723, December.
  6. Björn A. Hauksson, 2005. "Aggregate business fixed investment," Economics wp27_bjorn, Department of Economics, Central bank of Iceland.
  7. Julia K. Thomas & Aubhik Khan, 2009. "Collateral constraints, capital specificity and the distribution of production: the role of real and financial frictions in aggregate fluctuations," 2009 Meeting Papers 1133, Society for Economic Dynamics.
  8. Richard Holt, 2007. "Investment, irreversibility and financial imperfections: the rush to invest and the option to wait," Economics Bulletin, AccessEcon, vol. 5(10), pages 1-10.
  9. Julia Thomas & Aubhik Khan, 2012. "Uncertainty Shocks in an Economy with Collateral Constraints," 2012 Meeting Papers 1075, Society for Economic Dynamics.
  10. Simona Mateut & Paul Mizen & Ydriss Ziane, . "No Going Back: How the Production Process Affects Access to Short-term Credit," Discussion Papers 12/14, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM).
  11. Gal, Peter & Pinter, Gabor, 2013. "Capital over the business cycle: renting versus ownership," Bank of England working papers 478, Bank of England.
  12. Rainer Niemann & Caren Sureth, 2011. "The Impact of Differential Capital Income Taxation on the Value of Risky Projects," Economics Bulletin, AccessEcon, vol. 31(2), pages 1047-1054.
  13. Alessandra Guariglia & John Tsoukalas & Serafeim Tsoukas, . "Investment, irreversibility, and financing constraints in transition economies," Discussion Papers 10/03, University of Nottingham, School of Economics.

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