Corresponding author: Wouter Den Haan, London School of Economics and Political Science, Houghton Street, London, WC2A 2AE, UK. Email: firstname.lastname@example.org.
The Role of Debt and Equity Finance Over the Business Cycle*
Article first published online: 8 AUG 2012
© 2012 The Author(s). The Economic Journal © 2012 Royal Economic Society
The Economic Journal
Volume 122, Issue 565, pages 1262–1286, December 2012
How to Cite
Covas, F. and Den Haan, W. J. (2012), The Role of Debt and Equity Finance Over the Business Cycle. The Economic Journal, 122: 1262–1286. doi: 10.1111/j.1468-0297.2012.02528.x
We thank Walter Engert, Antonio Falato, Nobuhiro Kiyotaki, André Kurmann, Ellen McGrattan, Césaire Meh, Miguel Molico, Vincenzo Quadrini, Andrew Scott, Pedro Teles and an anonymous referee for useful comments. Den Haan thanks the Netherlands Organisation for Scientific Research (NWO) for financial support.
- Issue published online: 12 NOV 2012
- Article first published online: 8 AUG 2012
- Accepted manuscript online: 23 APR 2012 10:04AM EST
- Submitted: 21 January 2011 Accepted: 1 March 2012
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.