Financial Structure and Macroeconomic Volatility: Theory and Evidence

Harry Huizinga and Dantao Zhu

No 5697, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: This paper presents a simple model capturing differences between debt and equity finance to examine how financial structure matters for macroeconomic volatility. Debt finance is relatively cheap in the sense that debt holders need to verify relatively few profitability states, but debt finance may lead to costly bankruptcy. At the aggregate level, a more debt-based financial structure leads to a higher bankruptcy rate. Therefore, aggregate output is more variable in case of a heavy reliance on debt finance. This paper provides empirical evidence that countries with more equity finance have a lower variance of GDP and a lower probability of episodes of negative economic growth.

Keywords: Financial structure; Macroeconomic volatility; Bankruptcy costs (search for similar items in EconPapers)
JEL-codes: C24 E32 E44 G33 (search for similar items in EconPapers)
Date: 2006-06
New Economics Papers: this item is included in nep-bec, nep-fdg, nep-fin and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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