Financial Constraints Risk

42 Pages Posted: 23 Jun 2003 Last revised: 5 Feb 2012

See all articles by Toni M. Whited

Toni M. Whited

University of Michigan, Stephen M. Ross School of Business; National Bureau of Economic Research

Guojun Wu

University of Houston; China Academy of Financial Research (CAFR)

Date Written: May 12, 2005


We construct an index of firms' external finance constraints via GMM estimation of an investment Euler equation. Unlike the commonly used KZ index, ours is consistent with firm characteristics associated with external finance constraints. Constrained firms' returns move together, suggesting the existence of a financial constraints factor. This factor earns a positive but insignificant average return. Much of the variation in this factor cannot be explained by the Fama-French and momentum factors. Cross-sectional regressions of returns on our index and other firm characteristics show that constrained firms earn higher returns and that the financial-constraints effect dominates the size effect.

Keywords: Financial Constraints, Stock Returns, Undiversifiable Risk

JEL Classification: G12, G31

Suggested Citation

Whited, Toni M. and Wu, Guojun, Financial Constraints Risk (May 12, 2005). Available at SSRN: or

Toni M. Whited (Contact Author)

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

National Bureau of Economic Research ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Guojun Wu

University of Houston ( email )

220F Melcher Hall
Houston, TX 77204-6021
United States
713-743-4813 (Phone)
713-743-4789 (Fax)


China Academy of Financial Research (CAFR)

1954 Huashan Road
Shanghai P.R.China, 200030

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