When Liquidity Matters: Firm Balance Sheets during Large Crises

Mahdi Ebsim, Miguel Faria-e-Castro and Julian Kozlowski

No 2025-019, Working Papers from Federal Reserve Bank of St. Louis

Abstract: We study how aggregate shocks shape the joint dynamics of credit spreads, debt, and liquid asset holdings for nonfinancial firms, focusing on the Great Financial Crisis (GFC) and COVID-19. Both episodes saw sharp credit spread increases and investment declines, but debt and liquidity fell during the GFC and rose during COVID-19. Cross-sectionally, leverage drove spreads and investment in the GFC, while liquidity dominated during COVID-19. We build a macro-finance model of firm capital structure with a liquidity motive for working capital. Calibrated to data, it attributes the GFC to real and financial shocks, and COVID-19 to an additional liquidity shock.

Keywords: credit spreads; liquidity; Great Recession; COVID-19 (search for similar items in EconPapers)
JEL-codes: E6 G2 (search for similar items in EconPapers)
Pages: 63 pages
Date: 2025-08-14, Revised 2025-08-14
New Economics Papers: this item is included in nep-dge and nep-fdg
Note: Supersedes working paper 2020-035, "Credit and Liquidity Policies during Large Crises" (https://doi.org/10.20955/wp.2020.035)
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DOI: 10.20955/wp.2025.019

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