IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper or follow this series

Liquidity, Assets and Business Cycles

  • Shouyong Shi

Equity price is cyclical and often leads the business cycle by one or two quarters. These observations lead to the hypothesis that shocks to equity market liquidity are an independent source of the business cycle. In this paper I construct a model to evaluate this hypothesis. The model is easy for aggregation and for the construction of the recursive competitive equilibrium. After calibrating the model to the US data, I find that a negative liquidity shock in the equity market can generate large drops in investment and output but, contrary to what one may conjecture, the shock generates an equity price boom. This response of equity price occurs as long as a negative liquidity shock tightens firms' financing constraints on investment. Thus, liquidity shocks to the equity market cannot be the primary driving force of the business cycle. For equity price to fall as it typically does in a recession, a negative liquidity shock must be accompanied or caused by other shocks that reduce the need for investment sufficiently and relax firms' financing constraints on investment. I illustrate that a strong negative productivity shock is a good candidate of such concurrent shocks.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.economics.utoronto.ca/public/workingPapers/tecipa-434.pdf
File Function: Main Text
Download Restriction: no

Paper provided by University of Toronto, Department of Economics in its series Working Papers with number tecipa-434.

as
in new window

Length: Unknown pages
Date of creation: 14 Jun 2011
Date of revision:
Handle: RePEc:tor:tecipa:tecipa-434
Contact details of provider: Postal: 150 St. George Street, Toronto, Ontario
Phone: (416) 978-5283

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Russell Cooper & John Haltiwanger & Laura Power, 1995. "Machine Replacement and the Business Cycle: Lumps and Bumps," NBER Working Papers 5260, National Bureau of Economic Research, Inc.
  2. Ben Bernanke & Mark Gertler & Simon Gilchrist, 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," NBER Working Papers 6455, National Bureau of Economic Research, Inc.
  3. Williamson, Stephen D, 1987. "Financial Intermediation, Business Failures, and Real Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 95(6), pages 1196-1216, December.
  4. Mark Doms & Timothy Dunne, 1994. "Capital Adjustment Patterns in Manufacturing Plants," Working Papers 94-11, Center for Economic Studies, U.S. Census Bureau.
  5. Andrea Ajello, 2012. "Financial intermediation, investment dynamics and business cycle fluctuations," Finance and Economics Discussion Series 2012-67, Board of Governors of the Federal Reserve System (U.S.).
  6. Gilchrist, Simon & Leahy, John V., 2002. "Monetary policy and asset prices," Journal of Monetary Economics, Elsevier, vol. 49(1), pages 75-97, January.
Full references (including those not matched with items on IDEAS)

This item is featured on the following reading lists or Wikipedia pages:

  1. Canadian Macro Study Group

When requesting a correction, please mention this item's handle: RePEc:tor:tecipa:tecipa-434. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (RePEc Maintainer)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.