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Corporate Debt Structure, Precautionary Savings, and Investment Dynamics

Jasmine Xiao

No 887, 2018 Meeting Papers from Society for Economic Dynamics

Abstract: This paper documents two facts on the Great Recession. First, public firms that switched from bank finance to bond finance actually experienced a slower recovery in investment, despite having no shortage of credit compared to those that did not switch. Second, their debt substitution was accompanied by a substantial increase in cash holdings. As firms substitute toward bonds when bank lending is impaired, they lose the ability to restructure debt to avoid default. Debt substitution thus strengthens firms’ precautionary incentive to simultaneously increase cash holdings at the expense of investment, as they optimally trade-off growth against self-insurance. Model simulations suggest that this “precautionary savings” channel can account for a substantial fraction of the decline in aggregate investment in the recent recession. I show that embedding balance sheet adjustment in a business-cycle model improves the model’s amplification, and helps to disentangle shocks to credit demand from shocks to credit supply.

New Economics Papers: this item is included in nep-cfn and nep-dge
Date: 2018
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Working Paper: Corporate Debt Structure, Precautionary Savings, and Investment Dynamics (2016) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed018:887

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