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Corporate Leverage and Financial Fragility in General Equilibrium

Author

Listed:
  • Andrew T. Levin

    (Monetary Affairs Federal Reserve Board)

  • Fabio M. Natalucci

Abstract

We provide analytical and empirical underpinnings for the notion that the financial fragility of the aggregate economy depends on the balance sheet conditions of the corporate sector. First, we obtain time-varying semiparametric estimates of the relationship between the debt-equity ratio and the credit spread on publicly-traded bonds using a newly-constructed firm-level dataset. The estimated leverage-spread schedule exhibits statistically significant nonlinearity that is consistent with the theoretical predictions of a canonical debt-contracting problem with asymmetric information. We then proceed to analyze the aggregate implications of this nonlinearity by obtaining a second-order approximation of a dynamic general equilibrium model with financial market frictions. Finally, using this framework, we quantify the degree of financial fragility of the U.S. economy during the high-leverage period of the late 1980s compared with the low-leverage period of the late 1990s

Suggested Citation

  • Andrew T. Levin & Fabio M. Natalucci, 2005. "Corporate Leverage and Financial Fragility in General Equilibrium," Computing in Economics and Finance 2005 182, Society for Computational Economics.
    • Handle: RePEc:sce:scecf5:182
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    Cited by:

    1. Mesly, Olivier & Chkir, Imed & Racicot, François-Éric, 2019. "Predatory cells and puzzling financial crises: Are toxic products good for the financial markets?," Economic Modelling, Elsevier, vol. 78(C), pages 11-31.
    2. Stijn Claessens & M Ayhan Kose, 2018. "Frontiers of macrofinancial linkages," BIS Papers, Bank for International Settlements, number 95.

    More about this item

    Keywords

    financial market frictions; nonlinearities;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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