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Financial Frictions and Investment: Requiem in Q

Author

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  • Russell Cooper

    (University of Texas)

  • Joao Ejarque

    (University of Copenhagen)

Abstract

Understanding the nature of financial frictions faced by firms is relevant for both monetary and fiscal policy experiments. Empirical investment studies commonly find that proxies for firms' internal funds are significant as explanatory variables, particularly in the Q-theory based regression framework. These findings are often interpreted as evidence of financial frictions. This paper investigates that inference by specifying and estimating a class of dynamic optimization models where imperfectly competitive firms face financial constraints. Market power induces the principal link between investment and internal funds. We find no evidence to support the argument that capital market imperfections contribute to the relationship between investment and profitability. (Copyright: Elsevier)

Suggested Citation

  • Russell Cooper & Joao Ejarque, 2003. "Financial Frictions and Investment: Requiem in Q," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(4), pages 710-728, October.
  • Handle: RePEc:red:issued:v:6:y:2003:i:4:p:710-728
    DOI: 10.1016/j.red.2003.08.001
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    References listed on IDEAS

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