The Magnitude and Cyclical Behavior of Financial Market Frictions

Abstract

We analyze a new panel data set that includes balance sheet information, measures of expected default risk, and credit spreads on publicly-traded debt for more than 900 firms over the period 1997Q1 through 2003Q3. We obtain precise time-specific estimates of the financial frictions parameter underlying the benchmark financial accelerator model of Bernanke, Gertler, and Gilchrist (1999) and clearly reject the null hypothesis of no credit market imperfections; furthermore, for the expansionary period through mid-2000, these estimates are quite similar to the calibrated values used in previous research. Finally, we find that financial market frictions exhibit strong cyclical pattern, with parameter estimates rising by a factor of two during the latest economic downturn before returning to pre-recession levels in 2003.

Investment Shocks and the Relative Price of Investment

“…The important di¤erence is that t is just an exogenous shock in our framework, while net worth is a key endogenous variable in the agency cost model. Figure 3 sheds more light on this relationship, by comparing the cyclical behavior of the t series implied by our estimation to that of a measure of the external …nance premium, the spread between the yields of the lowest rated category (Baa) of investment grade securities and the highest category (Aaa) (Levin, Natalucci, and Zakrajsek (2004)). These two series have a strong negative correlation, indicating that MEI shocks indeed tend to be negative when …nancial markets function less smoothly.…”

Interest Rates and Business Cycles in Emerging Economies: The Role of Financial Frictions

“…The reason for this is twofold. First, it is the book value of debt that has to be returned to the lender, rather than the market value, as pointed out by Levin et al (2006). Secondly, trade in corporate debt is rare, except for the largest rms, and frequently illiquid, not least in emerging economies, so no reliable data is available.…”

“…21 Entrepreneurial labor is assumed to be inelastic and normalized to 1. dominance of shocks that aect only the demand for credit guarantees that this pattern will be retained. On the other hand, any shocks to the nancial accelerator, e.g., a risk shock in the spirit of Christiano et al (2010) or a monitoring cost shock á la Levin et al (2006) would aect the slope of the loan supply curve and possibly break this pattern. For these reasons we decided to abstain from shocks to the accelerator and work with a parsimonious model in which the TFP shock is the sole source of uncertainty.…”

An Estimated Structural Model of Entrepreneurial Behavior

“…The liquidation loss, λ, is set to 35 percent. This is at the upper range of the estimates found by Levin, Natalucci and Zakrajšek (2004). Given that a significant portion of farm assets are site specific, high loss rates are not implausible.…”