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The Role of Debt and Equity Finance over the Business Cycle

Francisco Covas () and Wouter den Haan
Authors registered in the RePEc Author Service: Wouter Denhaan ()

Staff Working Papers from Bank of Canada

Abstract: The authors show that debt and equity issuance are procyclical for most listed U.S. firms. The procyclicality of equity issuance decreases monotonically with firm size. At the aggregate level, however, the authors' results are not conclusive: issuance is countercyclical for very large firms that, although few in number, have a large effect on the aggregate because of their enormous size. If firms use the standard one-period contract, then the shadow price of external funds is procyclical and the cyclicality decreases with firm size. This property generates equity to be procyclical and--as in the data--the procyclicality decreases with firm size. Other factors that cause equity to be procyclical in the model are a countercyclical price of risk and a countercyclical cost of equity issuance. The model (i) generates a countercyclical default rate, (ii) magnifies shocks, and (iii) generates a stronger cyclical response for small firms, whereas the model without equity does the exact opposite.

Keywords: Financial stability; Business fluctuations and cycles (search for similar items in EconPapers)
JEL-codes: E3 G1 G3 (search for similar items in EconPapers)
Pages: 65 pages
Date: 2006
New Economics Papers: this item is included in nep-bec, nep-cfn, nep-dge and nep-mac
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Related works:
Journal Article: The Role of Debt and Equity Finance Over the Business Cycle (2012) Downloads
Working Paper: The Role of Debt and Equity Finance over the Business Cycle (2007) Downloads
Working Paper: The role of debt and equity finance over the business cycle (2006) Downloads
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