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Why does the Cost of Credit Intermediation Increase for Small Firms Relative to Large Firms during Recessions? A Conceptual and Empirical Analysis

Author

Listed:
  • Miguel Ramirez

    (Department of Economics, Trinity College)

  • Aalok Pandey

    (Department of Economics, Trinity College)

Abstract

The Great Recession of 2007-09 has had a devastating and long-lasting effect on the US economy. New Institutional Theories (NIT) of finance contend that part of the explanation for the amplification and duration of economic recessions resides in the presence of asymmetric information and market imperfections in the credit market. During recessions, smaller firms without established credit records and low net worth find that access to credit is, at best, limited and very costly. These firms are forced to cut back on their investment and consumption spending which, in turn, exacerbates the recession via a downward spiral of self-reinforcing effects. Following the lead of Walker (2010), this paper estimates a Vector Error Correction Model (VECM) that incorporates economic and financial factors that affect the cost of credit intermediation for small and large firms during the 1998-2011 period. It also examines the impact of recession on these factors as well as the prices that firms pay for access to credit. The reported estimates suggest that the impact of economic recession on the cost of credit intermediation was significant. The results also indicate that the cost of credit intermediation decreases in a recession; however, the decrease is more pronounced in the case of large firms as compared to small firms.

Suggested Citation

  • Miguel Ramirez & Aalok Pandey, 2012. "Why does the Cost of Credit Intermediation Increase for Small Firms Relative to Large Firms during Recessions? A Conceptual and Empirical Analysis," Working Papers 1205, Trinity College, Department of Economics.
    • Handle: RePEc:tri:wpaper:1205
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    File URL: http://www3.trincoll.edu/repec/WorkingPapers2012/WP12-05.pdf
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    References listed on IDEAS

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    Cited by:

    1. Louisa Kammerer & Miguel Ramirez, 2018. "Did Smaller Firms Face Higher Costs of Credit During the Great Recession? A Vector Error Correction Analysis with Structural Breaks," Research in Applied Economics, Macrothink Institute, vol. 10(3), pages 1-23, June.

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    More about this item

    Keywords

    Asymmetric information; adverse selection; cointegration; Credit Rationing Model; Financial Accelerator Model; moral hazard; recession; and Vector Error Correction Model (VECM).;
    All these keywords.

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles

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