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An alternative method for measuring financial frictions

  • Uluc Aysun

    (University of Connecticut)

Costly state verification models predict that the sensitivity of borrowing costs to financial leverage is positively related to the level of state verification costs (financial frictions). This paper constructs a measure of financial frictions that is consistent with this prediction of theory. Using bond deals from 47 countries, financial frictions are captured as the sensitivity of bond spreads to the issuing firms' financial leverage. This dynamic measure of financial frictions provides new insights into three characteristics of financial frictions. 1) In contrast to the inferences from widely-used measures, financial frictions display a large degree of variability, and have decreased over time. 2) The effect of financial frictions on private credit supply has decreased both in significance and magnitude over time. 3) Bankruptcy reforms, in general have not been effective in improving creditor/borrower rights.

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Paper provided by University of Connecticut, Department of Economics in its series Working papers with number 2009-34.

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Length: 38 pages
Date of creation: Oct 2009
Date of revision:
Handle: RePEc:uct:uconnp:2009-34
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Web page: http://www.econ.uconn.edu/

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