The author would like to thank Enrique Mendoza, Jonathan Heathcote, Kent Kimbrough and Michelle Connolly for many helpful comments on an earlier version of this article. Please address correspondence to: Katherine A. Smith, Department of Economics, U.S. Naval Academy, 589 McNair Road, Annapolis, MD 21402, USA. E-mail: firstname.lastname@example.org.
CAN FINANCING CONSTRAINTS EXPLAIN THE ASSET PRICING PUZZLES IN PRODUCTION ECONOMIES?*
Article first published online: 29 AUG 2011
© (2011) by the Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association
International Economic Review
Volume 52, Issue 3, pages 739–765, August 2011
How to Cite
Smith, K. A. (2011), CAN FINANCING CONSTRAINTS EXPLAIN THE ASSET PRICING PUZZLES IN PRODUCTION ECONOMIES?. International Economic Review, 52: 739–765. doi: 10.1111/j.1468-2354.2011.00648.x
Manuscript received January 2008; revised September 2009.
- Issue published online: 29 AUG 2011
- Article first published online: 29 AUG 2011
General Equilibrium asset pricing models have a difficult time simultaneously delivering a sizable equity premium, a low and counter cyclical real risk free rate, and cyclical variation in return volatility. To explain these stylized facts, this article introduces occasionally binding financing constraints that impede producers’ ability to invest. The financial frictions drive a wedge between the marginal rate of substitution and firms’ internal stochastic discount factors so that the shadow value of capital is not tied to the average price of capital. The model delivers higher and more volatile asset returns during recessions as well as a counter cyclical equity premium.