Financial Intermediation, Investment Dynamics and Business Cycle Fluctuations

Abstract

I use micro data to quantify key features of U.S. firm financing. In particular, I establish that a substantial 35% of firms’ investment is funded using financial markets. I then construct a dynamic equilibrium model that matches these features and fit the model to business cycle data using Bayesian methods. In the model, financial intermediaries enable trades of financial assets, directing funds towards investment opportunities, and charge an intermediation spread to cover their costs. According to the model estimation, exogenous shocks to the intermediation spread explain 40% of GDP and 60% of investment volatility.

Keywords: DSGE model, Financial frictions, Financial shocks, Bayesian estimation, Capital expenditure financing

JEL Classification: E30, E22, E44, C11, G1, G21, G30