Does the Financial Crisis Affect Distressed or Constrained Firms More Heavily?

Abstract

We develop a framework to investigate the impact of the financial crisis starting in 2007 and employ an extended GARCH model to test for spillover and contagion effects originating from the financial sector. We find that the financial crisis affected financially distressed firms more heavily than undistressed firms and that financial constraints did not play an equally crucial role during the crisis. Overall, the analysis shows that the financial sector affected the returns of nonfinancial firms during the crisis. We find little evidence that the turbulence in the financial sector expressed in terms of volatility fully encroached upon nonfinancial firms.