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Default Rate and Price of Capital in a Costly External Finance Model

26 Pages Posted: 22 Aug 2008  

Juan Pablo Medina

Central Bank of Chile

Date Written: June 1, 2006


Financial frictions have been used to enrich mechanisms transmission in macroeconomics. However, the predictions of real business cycle models of costly external finance imply a procyclical default rate, external premium and relative price of capital which seems at odds with the data. In this article, we include technology shocks that affect the average productivity and idiosyncratic risk of capital producers in a standard costly external finance model. These elements enhance the model to deliver a countercyclical default rate, external finance and relative price of capital premium which are more consistent with the data and contrary to the results obtained with a sector-neutral productivity shock. Intuitively, if the entrepreneurs' investment projects become more productive in average, the relative price of capital and the default rate fall while investment and output increase. Using data on the relative price of capital, we perform a calibration of this type of shocks which highlights its business-cycle relevante.

Keywords: Financial Constraints, Costly External Finance, Default Rate

JEL Classification: E32, E22, E44

Suggested Citation

Medina, Juan Pablo, Default Rate and Price of Capital in a Costly External Finance Model (June 1, 2006). Revista de Analisis Economico, Vol. 21, No. 1, 2006. Available at SSRN:

Juan Pablo Medina (Contact Author)

Central Bank of Chile ( email )

Huerfanos 1185

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