We develop a methodology to study whether and how a financial-sector crisis can spill over to the real economy, and apply it to the case of the ongoing subprime mortgage crisis. If there is a spillover, does it manifest itself primarily by reducing consumer confidence and consumer demand? Is there also a supply-side channel through a tightened liquidity constraint faced by non-financial firms? Since most firms appear to have much larger cash holdings than in the past, some suggest that a liquidity constraint is not likely to be a significant factor for non-financial firms. We propose a methodology to estimate the importance of these two channels for spillovers. We first propose an index of a firm's sensitivity to a shock to consumer confidence, based on its response to the 9/11 shock in 2001. We then construct a separate firm-level index on financial constraint based on Whited and Wu (2006). As a robustness check, we also construct an alternative sector-level index of a firm's intrinsic demand for external finance, based on the work of Rajan and Zingales (1998). We find robust evidence suggesting that both channels are at work, but that a tightened liquidity squeeze appears to be economically more important than reduced consumer confidence or spending in explaining cross-firm differences in stock price declines.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
14205.
Length: Date of creation: Jul 2008 Date of revision: Handle: RePEc:nbr:nberwo:14205
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Kathryn M.E. Dominguez & Linda L. Tesar, 2001.
"Exchange Rate Exposure,"
NBER Working Papers
8453, National Bureau of Economic Research, Inc.
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