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Firm Behaviour Under the Threat of Liquidation: Implications for Output, Investment & Business Cycle Transmission

Author

Listed:
  • Alistair Milne

    (University of Surrey)

  • Donald Robertson

Abstract

Cash balances of the firm follow a diffusion process, triggering liquidation when they cross a threshold value. Access to external funds is constrained. Shareholders are impatient. With these assumptions there is a precautionary motive for retaining earnings; the internal cost of funds and local risk-aversion are decreasing functions of net worth; and, in extensions of our basic model, output and investment are increasing functions of net worth. We numerically simulate aggregate behaviour of a population of such firms. Shocks to net worth lead to substantial and prolonged deviations from steady state, consistent with a financial mechanism of business cycle transmission.

Suggested Citation

  • Alistair Milne & Donald Robertson, 1994. "Firm Behaviour Under the Threat of Liquidation: Implications for Output, Investment & Business Cycle Transmission," School of Economics Discussion Papers 9402, School of Economics, University of Surrey.
    • Handle: RePEc:sur:surrec:9402
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    References listed on IDEAS

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    1. Pindyck, Robert S, 1991. "Irreversibility, Uncertainty, and Investment," Journal of Economic Literature, American Economic Association, vol. 29(3), pages 1110-1148, September.
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    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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