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

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  • De Graeve, Ferre

Abstract

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.

Suggested Citation

  • De Graeve, Ferre, 2008. "The external finance premium and the macroeconomy: US post-WWII evidence," Journal of Economic Dynamics and Control, Elsevier, vol. 32(11), pages 3415-3440, November.
  • Handle: RePEc:eee:dyncon:v:32:y:2008:i:11:p:3415-3440
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    More about this item

    Keywords

    External finance premium Financial frictions DSGE Bayesian estimation;

    JEL classification:

    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • 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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