Equity Capital, Bankruptcy Risk and the Liquidity Trap

Oren Levintal

No 2012-07, Working Papers from Bar-Ilan University, Department of Economics

Abstract: This paper explains the emergence of liquidity traps in the aftermath of large-scale financial crises, as happened in the US 1930s, Japan 1990s and recently in the US and Europe. The paper introduces a new balance sheet channel that links equity capital to the risk-free interest rate. When equity capital falls, bankruptcy risks rise. Firms become more vulnerable to external shocks, which makes financial disasters more likely to happen. Consequently, demand for safe assets increases, and the interest rate falls to the lower bound. Simulations show that the interest rate may stay at the lower bound for a long time.

Keywords: liquidity trap; financial crisis; rare disasters; equity capital; leverage; bankruptcy risk. (search for similar items in EconPapers)
JEL-codes: E32 E43 E44 E52 G12 G32 (search for similar items in EconPapers)
Pages: 47 pages
Date: 2012-05
New Economics Papers: this item is included in nep-ban and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://econ.biu.ac.il/sites/econ/files/working-papers/2012-07.pdf Working paper (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:biu:wpaper:2012-07

Access Statistics for this paper

More papers in Working Papers from Bar-Ilan University, Department of Economics Contact information at EDIRC.
Bibliographic data for series maintained by Department of Economics ().