The magnitude and Cyclical Behavior of Financial Market Frictions



Figure 8

1 Average model-implied recovery rate with μ = 0, weighted by the book value of bonds outstanding.

2 Average model-implied recovery rate with estimated μ , weighted by the book value of bonds
outstanding.

3 Average recovery rate at default weighted by the book value of the defaulted bond issue
(four-quarter moving average).

cyclically, amplifying the swings in borrowing and, consequently, in investment and
output.

Figure 9 shows the cyclical behavior of the model-implied external finance pre-
mium calculated using the solutions for
ω*t and σ*t and our estimates of the bankruptcy
cost parameter
μt. Smoothing through the Russian default in late 1998, the model-
implied external finance premium was close to zero across the entire cross-section of
firms until the end of 1999. As stock prices began to slide in early 2000, causing a
decline in firms’ net worth (i.e., market capitalization) and an increase in corporate
leverage, the external finance premium rose sharply, and the increase is economically
significant. Firms that account for a half of aggregate sample sales experienced an
increase in the external finance premium of at least 150 basis points, while firms that
account for one quarter of aggregate sample sales faced an increase in the external fi-
nance premium of more than 300 basis points. The external finance premium started
to decline at the end of the NBER-date recession but then jumped up again at the
end of 2002 in response to concerns about corporate governance.

To investigate the interaction between the cyclical behavior of our estimates of
μ and the dynamics of the external finance premium over the latest business cycle,

27



More intriguing information

1. Globalization, Redistribution, and the Composition of Public Education Expenditures
2. Does Presenting Patients’ BMI Increase Documentation of Obesity?
3. Private tutoring at transition points in the English education system: its nature, extent and purpose
4. Announcement effects of convertible bond loans versus warrant-bond loans: An empirical analysis for the Dutch market
5. Transgression et Contestation Dans Ie conte diderotien. Pierre Hartmann Strasbourg
6. Evaluating Consumer Usage of Nutritional Labeling: The Influence of Socio-Economic Characteristics
7. Indirect Effects of Pesticide Regulation and the Food Quality Protection Act
8. The name is absent
9. The name is absent
10. The name is absent
11. Smith and Rawls Share a Room
12. The name is absent
13. MANAGEMENT PRACTICES ON VIRGINIA DAIRY FARMS
14. The name is absent
15. The name is absent
16. Endogenous Heterogeneity in Strategic Models: Symmetry-breaking via Strategic Substitutes and Nonconcavities
17. The name is absent
18. The Composition of Government Spending and the Real Exchange Rate
19. The name is absent
20. Are combination forecasts of S&P 500 volatility statistically superior?