Real Effects of the Subprime Mortgage Crisis: Is it a Demand or a Finance Shock?

Hui Tong and Shang-Jin Wei

No 2008/186, IMF Working Papers from International Monetary Fund

Abstract: We develop a methodology to study how the subprime crisis spills over to the real economy. Does it manifest itself primarily through reducing consumer demand or through tightening liquidity constraint on non-financial firms? Since most non-financial firms have much larger cash holding than before, they appear unlikely to face significant liquidity constraint. We propose a methodology to estimate these two channels of spillovers. We first propose an index of a firm's sensitivity to consumer demand, based on its response to the 9/11 shock in 2001. We then construct a separate firm-level index on financial constraint based on Whited and Wu (2006). We find that both channels are at work, but a tightened liquidity squeeze is economically more important than a reduced consumer spending in explaining cross firm differences in stock price declines.

Keywords: WP; liquidity constraint; stock price; price movement; demand sensitivity; subprime mortgage crisis (search for similar items in EconPapers)
Pages: 37
Date: 2008-07-01
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Citations: View citations in EconPapers (50)

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Working Paper: Real Effects of the Subprime Mortgage Crisis: Is it a Demand or a Finance Shock? (2008)
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