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Firm Investment in Imperfect Capital Markets: A Structural Estimation

Author

Listed:
  • Sangeeta Pratap

    (ITAM)

  • Silvio Rendon

    (University of Western Ontario)

Abstract

In this paper we characterize and estimate the degree to which liquidity constraints affect real activity. We set up a dynamic model of firm investment and debt in which liquidity constraints enter explicitly into the firm's maximization problem, so that investment depends positively on the firm's financial position. The optimal policy rules are incorporated into a maximum likelihood procedure to estimate the structural parameters of the model. We identify liquidity constraints from the dynamics of a firm's evolution, as formalized by the dynamic estimation process, and find that they significantly affect investment decisions of firms. Firms ability to raise equity is about 73% of what it would have been under free capital markets. If firms can finance investment by issuing fresh equity, rather than with internal funds or debt, average capital stock is about 6% higher over a period of 20 years. Transitory interest rate shocks have a sustained impact on capital accumulation, which lasts for several periods. (Copyright: Elsevier)

Suggested Citation

  • Sangeeta Pratap & Silvio Rendon, 2003. "Firm Investment in Imperfect Capital Markets: A Structural Estimation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(3), pages 513-545, July.
  • Handle: RePEc:red:issued:v:6:y:2003:i:3:p:513-545
    DOI: 10.1016/S1094-2025(03)00019-X
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    Cited by:

    1. Francisco Covas & Wouter J. Den Haan, 2012. "The Role of Debt and Equity Finance Over the Business Cycle," Economic Journal, Royal Economic Society, vol. 122(565), pages 1262-1286, December.
    2. Pratap, Sangeeta & Urrutia, Carlos, 2004. "Firm dynamics, investment and debt portfolio: balance sheet effects of the Mexican crisis of 1994," Journal of Development Economics, Elsevier, vol. 75(2), pages 535-563, December.
    3. Sangeeta Pratap & Silvio Rendon, 2003. "Firm Investment in Imperfect Capital Markets: A Structural Estimation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(3), pages 513-545, July.
    4. Ono, Masanori, 2003. "A computational approach to liquidity-constrained firms over an infinite horizon," Journal of Economic Dynamics and Control, Elsevier, vol. 28(1), pages 189-205, October.
    5. Simon Gilchrist & Jae W. Sim, 2007. "Investment During The Korean Financial Crisis: A Structural Econometric Approach," Boston University - Department of Economics - Working Papers Series WP2007-001, Boston University - Department of Economics.
    6. Simon Gilchrist & Charles Himmelberg, 1999. "Investment: Fundamentals and Finance," NBER Chapters,in: NBER Macroeconomics Annual 1998, volume 13, pages 223-274 National Bureau of Economic Research, Inc.
    7. Felipe Meza & Carlos Urrutia & Sangeeta Pratap, 2018. "Credit Conditions, Dynamic Distortions, and Capital Accumulation in Mexican Manufacturing," 2018 Meeting Papers 875, Society for Economic Dynamics.
    8. Francesc Obiols-Homs, 2011. "On borrowing limits and welfare," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 14(2), pages 279-294, April.
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    11. Kirchesch, Kai, 2004. "Financial Risks, Bankruptcy Probabilities, and the Investment Behaviour of Enterprises," HWWA Discussion Papers 299, Hamburg Institute of International Economics (HWWA).
    12. Strebulaev, Ilya A. & Whited, Toni M., 2012. "Dynamic Models and Structural Estimation in Corporate Finance," Foundations and Trends(R) in Finance, now publishers, vol. 6(1–2), pages 1-163, November.
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    15. Jones, John Bailey & Pratap, Sangeeta, 2017. "An Estimated Structural Model of Entrepreneurial Behavior," Working Paper 17-7, Federal Reserve Bank of Richmond.
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    More about this item

    Keywords

    Investment; Liquidity constraints; Estimation of dynamic structural models; Financial accelerator;

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

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