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Empirical policy functions as benchmarks for evaluation of dynamic capital structure models

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  • Bazdresch, Santiago

Abstract

This paper presents a set of benchmark moments for evaluation or estimation of quantitative capital structure models. The moments are directly related to the models being studied: the main features of each models' empirical policy functions. The paper describe a general method for estimating these benchmarks and shows that they ‘capture’ a substantial part of the actual variation in firms actions in the data. Two versions of these benchmarks are presented: one dimensional ones and two dimensional ones. In both cases we express these as the total change in the control variable and the change relative to the change in the state variable. The empirical policy functions turn out to be smooth and mostly monotonous. Three key numbers that we suggest quantitative dynamic models have match closely are that within firms, for every 10% increase in debt relative to assets investment relative to assets declines 3.7%, debt issuance relative to market value decreases 1.1% and equity issuance relative to market value increases 0.5%.

Suggested Citation

  • Bazdresch, Santiago, 2011. "Empirical policy functions as benchmarks for evaluation of dynamic capital structure models," MPRA Paper 35509, University Library of Munich, Germany, revised 01 Nov 2011.
  • Handle: RePEc:pra:mprapa:35509
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    File URL: https://mpra.ub.uni-muenchen.de/51568/10/MPRA_paper_51568.pdf
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    References listed on IDEAS

    as
    1. Christopher A. Hennessy & Toni M. Whited, 2007. "How Costly Is External Financing? Evidence from a Structural Estimation," Journal of Finance, American Finance Association, vol. 62(4), pages 1705-1745, August.
    2. Murray Z. Frank & Vidhan K. Goyal, 2009. "Capital Structure Decisions: Which Factors Are Reliably Important?," Financial Management, Financial Management Association International, vol. 38(1), pages 1-37, March.
    3. Andrea Gamba & Alexander Triantis, 2008. "The Value of Financial Flexibility," Journal of Finance, American Finance Association, vol. 63(5), pages 2263-2296, October.
    4. Ilya A. Strebulaev, 2007. "Do Tests of Capital Structure Theory Mean What They Say?," Journal of Finance, American Finance Association, vol. 62(4), pages 1747-1787, August.
    5. Bayer, Christian, 2006. "Investment dynamics with fixed capital adjustment cost and capital market imperfections," Journal of Monetary Economics, Elsevier, vol. 53(8), pages 1909-1947, November.
    6. Carlos A. Molina, 2005. "Are Firms Underleveraged? An Examination of the Effect of Leverage on Default Probabilities," Journal of Finance, American Finance Association, vol. 60(3), pages 1427-1459, June.
    7. Fischer, Edwin O & Heinkel, Robert & Zechner, Josef, 1989. " Dynamic Capital Structure Choice: Theory and Tests," Journal of Finance, American Finance Association, vol. 44(1), pages 19-40, March.
    8. Shyam-Sunder, Lakshmi & C. Myers, Stewart, 1999. "Testing static tradeoff against pecking order models of capital structure," Journal of Financial Economics, Elsevier, vol. 51(2), pages 219-244, February.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    dynamic models of capital structure; policy function; value function; model evaluation;

    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • 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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