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External Financing and the Role of Financial Frictions over the Business Cycle: Measurement and Theory

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  • Ariel Zetlin-Jones
  • Ali Shourideh

    (University of Pennsylavnia)

Abstract

We examine the quantitative importance of financial market shocks in accounting for business cycle fluctuations. We emphasize the role financial markets play in reallocating funds from cash-rich, low productivity firms to cash-poor, high productivity firms. We use evidence on financial flows to analyze the importance of this role of financial markets. This evidence shows that in the aggregate, funds available to firms internally are more than adequate to finance investment. At the firm level, we find that for publicly traded firms (in Compustat), almost all investment is financed internally while, using a alternative data source (Amadeus), we find that most investment by privately held firms is financed through borrowing. These observations suggest that the quantitative impact of financial market shocks depend both on the sensitivity of investment and output of privately held firms to such shocks and on the extent to which the investment and output of publicly held firms respond to the actions of privately held firms. Motivated by these observations, we build a quantitative model featuring publicly and privately held firms that face collateral constraints and idiosyncratic risk over productivity. We model financial market shocks as shocks to the collateral constraints. In our model, each firm has a monopoly in producing a differentiated good and uses the goods produced by other firms as an input for production -- features that create non-financial linkages between publicly and privately held firms. In our calibrated model, we find that a shock to the collateral constraints which generates a one standard deviation decline in the debt-to-asset ratio leads to a 0.5% decline in aggregate output on impact, roughly comparable to the effect of a one standard deviation shock to aggregate productivity in a standard real business cycle model. In this sense, we find that disturbances in financial markets are a promising source of business cycle fluctuations when non-financial linkages across firms are sufficiently strong.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2012 Meeting Papers with number 321.

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Date of creation: 2012
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Handle: RePEc:red:sed012:321

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  1. Stephen Davis & John Haltiwanger & Ron Jarmin & Javier Miranda, 2006. "Volatility and Dispersion in Business Growth Rates: Publicly Traded Versus Privately Held Firms," Working Papers 06-17, Center for Economic Studies, U.S. Census Bureau.
  2. Simon Gilchrist & Charles P. Himmelberg, 1993. "Evidence on the role of cash flow for investment," Finance and Economics Discussion Series 93-7, Board of Governors of the Federal Reserve System (U.S.).
  3. Ariel Burstein & Christian Hellwig, 2008. "Welfare Costs of Inflation in a Menu Cost Model," American Economic Review, American Economic Association, vol. 98(2), pages 438-43, May.
  4. Aiyagari, S Rao, 1994. "Uninsured Idiosyncratic Risk and Aggregate Saving," The Quarterly Journal of Economics, MIT Press, vol. 109(3), pages 659-84, August.
  5. Yongseok Shin & Joe Kaboski & Francisco J. Buera, 2008. "Finance and Development: A Tale of Two Sectors," 2008 Meeting Papers 955, Society for Economic Dynamics.
  6. Chetty, Nadarajan & Weber, Andrea & Guren, Adam Michael & Day, Manoli, 2011. "Are Micro and Macro Labor Supply Elasticities Consistent? A Review of Evidence on the Intensive and Extensive Margins," Scholarly Articles 11878970, Harvard University Department of Economics.
  7. Huggett, Mark, 1993. "The risk-free rate in heterogeneous-agent incomplete-insurance economies," Journal of Economic Dynamics and Control, Elsevier, vol. 17(5-6), pages 953-969.
  8. George-Marios Angeletos, 2007. "Uninsured Idiosyncratic Investment Risk and Aggregate Saving," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 10(1), pages 1-30, January.
  9. Charles I. Jones, 2011. "Misallocation, Economic Growth, and Input-Output Economics," NBER Working Papers 16742, National Bureau of Economic Research, Inc.
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Cited by:
  1. Salas, Sergio, 2013. "Credit frictions and unexpected credit crunches," Journal of Macroeconomics, Elsevier, vol. 37(C), pages 161-181.
  2. Javier Bianchi, 2012. "Efficient Bailouts?," 2012 Meeting Papers 162, Society for Economic Dynamics.
  3. Francisco J. Buera & Roberto Fattal-Jaef & Yongseok Shin, 2014. "Anatomy of a Credit Crunch: From Capital to Labor Markets," NBER Working Papers 19997, National Bureau of Economic Research, Inc.
  4. Caterina Mendicino, 2012. "Collateral Requirements: Macroeconomic Fluctuations and Macro-Prudential Policy," Working Papers w201211, Banco de Portugal, Economics and Research Department.
  5. Yongseok Shin & Roberto Fattal Jaef & Francisco Buera, 2011. "The Anatomy of a Credit Crunch," 2011 Meeting Papers 1283, Society for Economic Dynamics.
  6. Lubik, Thomas A. & Sarte, Pierre-Daniel G. & Schwartzman, Felipe, 2014. "What Inventory Behavior Tells Us About How Business Cycles Have Changed," Working Paper 14-6, Federal Reserve Bank of Richmond.
  7. Paul Bergin & Ling Feng & Ching-Yi Lin, 2014. "Financial Frictions and Firm Dynamics," NBER Working Papers 20099, National Bureau of Economic Research, Inc.
  8. Francisco J. Buera & Benjamin Moll, 2012. "Aggregate Implications of a Credit Crunch," NBER Working Papers 17775, National Bureau of Economic Research, Inc.

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