Asset Prices and Business Cycles with Costly External Finance
34 Pages Posted: 28 Dec 2002
Date Written: November 2002
This paper asks whether the asset pricing fluctuations induced by the presence of costly external finance are empirically plausible. To accomplish this, we incorporate costly external finance into a dynamic stochastic general equilibrium model and explore its implications for the properties of the returns on the key financial assets, such as stocks, bonds and risky loans. We find that the mean and volatility of the equity premium is significantly higher than in comparable adjustment cost models. However, we show that these results require a procyclical financing premium, a property that seems at odds with the data.
Keywords: Costly External Finance, Business Cycles, Default Premium
JEL Classification: G1
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