The magnitude and Cyclical Behavior of Financial Market Frictions

provided by Research Papers in Economics

The Magnitude and Cyclical Behavior
of Financial Market Frictions *

Andrew T. Levin Fabio M. Natalucci Egon Zakrajsekt
Board of Governors of the Federal Reserve System

May 2004

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.

JEL Classification: D82, E22, G32

Keywords: financial accelerator, bankruptcy costs

*We thank David Bowman, Mark Carey, Mark Gertler, Simon Gilchrist, Refet GUrkaynak, and
Paul Harrison for helpful comments. Amanda Cox and Jason Grimm provided outstanding research
assistance. The views expressed in this paper are solely the responsibility of the authors and should
not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System
or of the Federal Reserve System.

tCorresponding author: Division of Monetary Affairs, MS-84, Board of Governors of the Federal
Reserve System, 20th Street & Constitution Avenue, NW, Washington D.C., 20551. Tel: (202) 728-
5864; Email: [email protected]

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