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Corporate Default, Investment, and the U.S. Great Depression

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  • Jiang, Lunan

Abstract

This paper investigates the role of corporate bond default risk during the U.S. Great Depression, and propose that the default risk is an effective amplifier of adverse technology and financial shocks. On the one hand, the massive wave of corporate bond defaults directly idled a considerable amount of capital, which was detrimental to production, investment, and employment. On the other hand, the indebted firms were inclined to cut more investment during the economic downturn, as they were also concerned about the increasing default risks besides the awful economic outlook. Based on the prominent work by Cooley and Quadrini(2001) and Miao and Wang(2010), I build a rational expectations DSGE model with firm default risk, which generates simulated investment dynamics that are much closer to the actual 1930s data series than in the standard RBC model. The model also predicts satisfactory declines in consumption, working hours and output. Moreover, I find that the default recovery rate decline caused by adverse financial shocks explains well the increasing corporate bond yield in the early 1930s.

Suggested Citation

  • Jiang, Lunan, 2014. "Corporate Default, Investment, and the U.S. Great Depression," MPRA Paper 77242, University Library of Munich, Germany, revised 01 Mar 2017.
    • Handle: RePEc:pra:mprapa:77242
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    File URL: https://mpra.ub.uni-muenchen.de/77242/1/MPRA_paper_77242.pdf
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    References listed on IDEAS

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    1. Giesecke, Kay & Longstaff, Francis A. & Schaefer, Stephen & Strebulaev, Ilya, 2011. "Corporate bond default risk: A 150-year perspective," Journal of Financial Economics, Elsevier, vol. 102(2), pages 233-250.
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    5. Bernanke, Ben S, 1983. "Nonmonetary Effects of the Financial Crisis in Propagation of the Great Depression," American Economic Review, American Economic Association, vol. 73(3), pages 257-276, June.
    6. Jermann, Urban J., 1998. "Asset pricing in production economies," Journal of Monetary Economics, Elsevier, vol. 41(2), pages 257-275, April.
    7. Hunter, Helen Manning, 1982. "The Role of Business Liquidity During the Great Depression and Afterwards: Differences Between Large and Small Firms," The Journal of Economic History, Cambridge University Press, vol. 42(4), pages 883-902, December.
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    10. Charles W. Calomiris, 1993. "Financial Factors in the Great Depression," Journal of Economic Perspectives, American Economic Association, vol. 7(2), pages 61-85, Spring.
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    Keywords

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    JEL classification:

    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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