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Asset Prices and Business Cycles with Financial Frictions

Author

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  • Ctirad Slavik

    (Goethe University in Frankfurt)

Abstract

Existing dynamic general equilibrium models have not been fully successful at explaining the high volatility of asset prices that we observe in the data. We construct a general equilibrium model with heterogeneous firms and financial frictions that addresses this issue. In each period only a fraction of firms can start new projects, which cannot be fully financed externally due to a financial constraint. We allow the tightness of the financial constraint to vary over time. Fluctuations in the tightness of the financial constraint result in fluctuations in the supply of equity and consequently in the price of equity. We calibrate the model to the U.S. data to assess the quantitative importance of fluctuations in the tightness of the financial constraint. The model generates a volatility in the price of equity comparable to the aggregate stock market while also fitting key aspects of the behavior of aggregate quantities.

Suggested Citation

  • Ctirad Slavik, 2011. "Asset Prices and Business Cycles with Financial Frictions," 2011 Meeting Papers 587, Society for Economic Dynamics.
    • Handle: RePEc:red:sed011:587
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    References listed on IDEAS

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    Cited by:

    1. Shouyong Shi & Christine Tewfik, 2015. "Financial Frictions, Investment Delay, and Asset Market Interventions," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 47(S2), pages 155-196, June.
    2. Marco Bassetto & Wei Cui, 2020. "A Ramsey Theory of Financial Distortions," Working Papers 775, Federal Reserve Bank of Minneapolis.
    3. Wei Cui & Sören Radde, 2020. "Search-based Endogenous Asset Liquidity and the Macroeconomy [Why Don’t US Issuers Demand European Fees for IPOs?]," Journal of the European Economic Association, European Economic Association, vol. 18(5), pages 2221-2269.
    4. Marco Del Negro & Gauti Eggertsson & Andrea Ferrero & Nobuhiro Kiyotaki, 2017. "The Great Escape? A Quantitative Evaluation of the Fed's Liquidity Facilities," American Economic Review, American Economic Association, vol. 107(3), pages 824-857, March.
    5. Schumacher, Malte D. & Żochowski, Dawid, 2017. "The risk premium channel and long-term growth," Working Paper Series 2114, European Central Bank.
    6. Shi, Shouyong, 2015. "Liquidity, assets and business cycles," Journal of Monetary Economics, Elsevier, vol. 70(C), pages 116-132.
    7. Andrea Ajello, 2016. "Financial Intermediation, Investment Dynamics, and Business Cycle Fluctuations," American Economic Review, American Economic Association, vol. 106(8), pages 2256-2303, August.
    8. Jaccard, Ivan, 2013. "Liquidity constraints, risk premia, and themacroeconomic effects of liquidity shocks," Working Paper Series 1525, European Central Bank.
    9. Wei Cui & Sören Radde, 2014. "Search-Based Endogenous Illiquidity and the Macroeconomy," Discussion Papers of DIW Berlin 1367, DIW Berlin, German Institute for Economic Research.
    10. Francesco Molteni, 2015. "Liquidity, Government Bonds and Sovereign Debt Crises," Working Papers 2015-32, CEPII research center.
    11. Marco Bassetto & Wei Cui, . "A Ramsey Theory of Financial Distortions," Staff Report, Federal Reserve Bank of Minneapolis.
    12. Cui, Wei, 2016. "Monetary–fiscal interactions with endogenous liquidity frictions," European Economic Review, Elsevier, vol. 87(C), pages 1-25.
    13. Wei Cui, 2017. "When Ramsey Searches for Liquidity," 2017 Meeting Papers 1342, Society for Economic Dynamics.

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