The Role of Debt and Equity Finance Over the Business Cycle

25 Pages Posted: 13 Nov 2012

See all articles by Francisco Covas

Francisco Covas

Board of Governors of the Federal Reserve System

Wouter J. den Haan

University of Amsterdam; Centre for Economic Policy Research (CEPR); Tinbergen Institute

Date Written: December 2012

Abstract

If equity issuance is introduced into the costly state verification framework and the friction firms face in raising equity is acyclical, then the model cannot simultaneously generate procyclical equity issuance and a countercyclical default rate. This requires a countercyclical equity issuance friction. With a countercyclical friction, the model can also overturn an undesirable feature of the standard debt‐only model: dampening of shocks. To quantitatively match observed patterns, the friction in the cost of raising equity has to vary a lot more over the business cycle than can be justified by estimates of cyclical changes in direct equity issuance costs.

Suggested Citation

Covas, Francisco and Den Haan, Wouter J., The Role of Debt and Equity Finance Over the Business Cycle (December 2012). The Economic Journal, Vol. 122, Issue 565, pp. 1262-1286, 2012. Available at SSRN: https://ssrn.com/abstract=2174834 or http://dx.doi.org/10.1111/j.1468-0297.2012.02528.x

Francisco Covas (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Wouter J. Den Haan

University of Amsterdam ( email )

Spui 21
Amsterdam, 1018 WB
Netherlands

HOME PAGE: http://www1.feb.uva.nl/toe/content/people/content/denhaan/pers.htm

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

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