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Abstract

Cash balances of the firm follow a diffusion process, triggering liquidation when they cross a threshold value. Access to external funds is constrained. Shareholders are impatient. With these assumptions there is a precautionary motive for retaining earnings; the internal cost of funds and local risk-aversion are decreasing functions of net worth; and, in extensions of our basic model, output and investment are increasing functions of net worth. We numerically simulate aggregate behaviour of a population of such firms. Shocks to net worth lead to substantial and prolonged deviations from steady state, consistent with a financial mechanism of business cycle transmission.

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Bibliographic Info

Paper provided by School of Economics, University of Surrey in its series School of Economics Discussion Papers with number 9402.

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Date of creation: Jan 1994
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Handle: RePEc:sur:surrec:9402

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Postal: Guildford, Surrey GU2 5XH
Phone: (01483) 259380
Fax: (01483) 259548
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Web page: http://www.surrey.ac.uk/economics/
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Related research

Keywords: Financing constraints; output; investment;

Find related papers by JEL classification:

• E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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1. Pindyck, Robert S, 1991. "Irreversibility, Uncertainty, and Investment," Journal of Economic Literature, American Economic Association, vol. 29(3), pages 1110-48, September.
   
   • Pindyck, Robert S., 1990. "Irreversibility, uncertainty, and investment," Working papers 3137-90., Massachusetts Institute of Technology (MIT), Sloan School of Management.
   • Robert S. Pindyck, 1991. "Irreversibility, Uncertainty, and Investment," NBER Working Papers 3307, National Bureau of Economic Research, Inc.
   • Pindyck, Robert, 1989. "Irreversibility, uncertainty, and investment," Policy Research Working Paper Series 294, The World Bank.
2. Bruce C. Greenwald & Joseph E. Stiglitz, 1993. "Financial Market Imperfections and Business Cycles," NBER Working Papers 2494, National Bureau of Economic Research, Inc.
   
   • Greenwald, Bruce C & Stiglitz, Joseph E, 1993. "Financial Market Imperfections and Business Cycles," The Quarterly Journal of Economics, MIT Press, vol. 108(1), pages 77-114, February.
3. Brennan, Michael J & Schwartz, Eduardo S, 1985. "Evaluating Natural Resource Investments," The Journal of Business, University of Chicago Press, vol. 58(2), pages 135-57, April.
4. Giuseppe Bertola & Ricardo J. Caballero, 1990. "Kinked Adjustment Costs and Aggregate Dynamics," NBER Chapters, in: NBER Macroeconomics Annual 1990, Volume 5, pages 237-296 National Bureau of Economic Research, Inc.
   
   • Bertola, G. & Caballero, R.J., 1990. "Kinked Adjustment Costs And Aggregate Dynamics," Discussion Papers 1990_20, Columbia University, Department of Economics.
5. repec:fth:coluec:465 is not listed on IDEAS
6. Dixit, Avinash, 1991. "A simplified treatment of the theory of optimal regulation of Brownian motion," Journal of Economic Dynamics and Control, Elsevier, vol. 15(4), pages 657-673, October.

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