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Long-Term Finance and Investment with Frictional Asset Markets

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This paper develops a theory of investment and maturity choices and studies its implications for the macroeconomy. The novel ingredient is an explicit secondary market with trading frictions which leads to a liquidity spread which increases with maturity and generates an upward sloping yield curve. As a result, trading frictions induce firms to borrow and invest at shorter horizons than in a frictionless benchmark. Economies with more severe frictions exhibit a steeper yield curve which further affects maturity and investment choices of rms. A model calibrated to match cross-country moments suggests that reductions in trading frictions-a new channel of financial development-can promote economic development. A policy intervention with government-backed financial intermediaries in the secondary market can improve liquidity and reduce the cost of long-term finance which promotes investment in longer-term projects and generates substantial welfare gains.

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  • Kozlowski, Julian, 2017. "Long-Term Finance and Investment with Frictional Asset Markets," Working Papers 2018-12, Federal Reserve Bank of St. Louis.
  • Handle: RePEc:fip:fedlwp:2018-012
    DOI: 10.20955/wp.2018.012
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    Keywords

    Debt maturity; Over-the-counter market; Liquidity; Secondary markets;

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance

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