The Real Effects of Financing and Trading Frictions

59 Pages Posted: 23 Mar 2016 Last revised: 20 Jun 2021

Date Written: June 18, 2019

Abstract

I develop a model that studies the interplay between investors' trading frictions and firms' financial constraints and the ensuing effects on corporate policies. The model shows that bid-ask spreads increase not only the cost of external financing but also the cost of internal funds, leading to smaller cash reserves and larger payouts. As a result, firm's financial constraints tighten, liquidation risk increases, investment decreases, and firm value declines. These outcomes are reinforced when internalized by liquidity providers, giving rise to a feedback that makes the bid-ask spread wider and amplifies its detrimental effects on firm financial constraints and value.

Keywords: Financial constraints, transaction costs, real effects of financial markets, small firms

JEL Classification: G32, G35, G31, G28

Suggested Citation

Zucchi, Francesca, The Real Effects of Financing and Trading Frictions (June 18, 2019). Available at SSRN: https://ssrn.com/abstract=2750499 or http://dx.doi.org/10.2139/ssrn.2750499

Francesca Zucchi (Contact Author)

Federal Reserve Board ( email )

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

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