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The external finance premium and the macroeconomy: US post-WWII evidence

  • De Graeve, Ferre

The central variable of theories of financial frictions--the external finance premium--is unobservable. This paper distils the external finance premium from a Dynamic Stochastic General Equilibrium (DSGE) model estimated on US macroeconomic data covering the period 1954 to 2004. Within the DSGE framework, movements in the premium can be given an interpretation in terms of shocks driving business cycles. A key result is that the estimate--based solely on non-financial macroeconomic data--picks up over 70% of the dynamics of lower grade corporate bond spreads. The paper also identifies a gain in fitting key macroeconomic aggregates by including financial frictions in the model and documents how shock transmission is affected.

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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 32 (2008)
Issue (Month): 11 (November)
Pages: 3415-3440

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Handle: RePEc:eee:dyncon:v:32:y:2008:i:11:p:3415-3440
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

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