The Magnitude and Cyclical Behavior of Financial Market Frictions

By Andrew T. Levin, Fabio Natalucci, Egon Zakraǰsek. 2004

135 citations recorded by the source corpus.

We quantify the cross-sectional and time-series behavior of the wedge between the cost of external and internal finance by estimating the structural parameters of a canonical debt-contracting model with informational frictions. For this purpose, we construct a new dataset that includes balance sheet information, measures of expected default risk, and credit spreads on publicly traded debt for about 900 U.S. firms over the period 1997Q1 to 2003Q3. Using nonlinear least squares, we obtain precise time-specific estimates of the bankruptcy cost parameter and consistently reject the null hypothesis of frictionless financial markets. For most of the firms in our sample, the estimated premium on external finance was very low during the expansionary period 1997-99, but rose sharply in 2000--especially for firms with higher ratios of debt to equity--and remained elevated until early 2003.

Subfields: Accounting, Finance

View Paper: https://www.semanticscholar.org/paper/93399be6a52f7b3177997bc6e8e910e3725e9c3a

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Citations in the corpus

The External Finance Premium and the Macroeconomy: Us Post-Wwii Evidence (2008, unknown): “Another approach is adopted by Levin et al. (2004).”
Optimal interest rate rules, asset prices, and credit frictions (2005, background): “Levin et al. (2004) report micro-based evidence showing that, during the boom of the late 1990s in the U.S., credit spreads on corporate debt were historically low.”
The Role of Debt and Equity Finance Over the Business Cycle (2012, background): “In particular, Levin, Natalucci, and Zakrajsek (2004) analyze the case with = 1 and document using an estimated version of the model that observed changes in idiosyncratic volatility and observed changes in leverage caused by changes in the value of net worth cannot generate substantial changes in…”
Credit, Vacancies and Unemployment Fluctuations (2014, background): “These findings were corroborated by Altman et al. (2005), who examine corporate bond recovery rates over 1982–2002.9 Levin et al. (2004), using firm-level data over the period 1997Q2 to 2003Q3, estimate the value of µt in this class of debt contracts consistent with the spread on corporate bonds.”
Monetary Policy, Financial Conditions, and Financial Stability (2014, background): “For example, Levin, Natalucci, and Zakraǰsek (2004) find a sharp rise in external finance premiums for businesses during the 2001 recession, and Iacoviello (2005) shows that changes in home equity affect household borrowing and spending by more than a conventional wealth effect.”