Abstract

http://ssrn.com/abstract=2434156
 


 



External Equity Financing Shocks, Financial Flows, and Asset Prices


Frederico Belo


University of Minnesota; National Bureau of Economic Research (NBER)

Xiaoji Lin


Ohio State University (OSU) - Fisher College of Business

Fan Yang


The University of Hong Kong

November 26, 2014

Charles A. Dice Center Working Paper No. 2014-08
Fisher College of Business Working Paper No. 2014-03-08

Abstract:     
The ability of corporations to raise external equity finance varies with macroeconomic conditions, suggesting that the cost of equity issuance is time-varying. Using cross sectional data on U.S. publicly traded firms, we construct an empirical proxy of an aggregate shock to the cost of equity issuance, which we interpret as a financial shock. We show that this shock captures systematic risk, and that exposure to this shock helps price the cross section of stock returns including book-to-market, investment, and size portfolios. We propose a dynamic investment-based model with stochastic equity issuance costs and a collateral constraint to interpret the empirical findings. Our central finding is that time variation in external equity financing costs is important for the model to quantitatively capture the joint dynamics of firms’ asset prices, real quantities, and financing flows. In the model, growth firms, high investment firms, and large firms, can substitute more easily debt financing for equity financing when it becomes more costly to raise external equity, hence these firms are less risky in equilibrium. The model also replicates the failure of the unconditional CAPM in pricing the cross section of stock returns.

Number of Pages in PDF File: 59

Keywords: Issuance shocks, asset pricing, book-to-market, investment, costly external financing, collateral constraint

JEL Classification: E23, E44, G12

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Date posted: May 9, 2014 ; Last revised: November 26, 2014

Suggested Citation

Belo, Frederico and Lin, Xiaoji and Yang, Fan, External Equity Financing Shocks, Financial Flows, and Asset Prices (November 26, 2014). Charles A. Dice Center Working Paper No. 2014-08; Fisher College of Business Working Paper No. 2014-03-08. Available at SSRN: http://ssrn.com/abstract=2434156 or http://dx.doi.org/10.2139/ssrn.2434156

Contact Information

Frederico Belo
University of Minnesota ( email )
19th Avenue South
Minneapolis, MN 55455
United States
National Bureau of Economic Research (NBER) ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Xiaoji Lin (Contact Author)
Ohio State University (OSU) - Fisher College of Business ( email )
2100 Neil Avenue
Columbus, OH 43210-1144
United States
Fan Yang
The University of Hong Kong ( email )
Pokfulam Road
Hong Kong, Pokfulam HK
China
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