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Liquidity, Assets and Business Cycles

Shouyong Shi

Working Papers from University of Toronto, Department of Economics

Abstract: I construct a tractable model to evaluate the liquidity shock hypothesis that exogenous shocks to equity market liquidity are an important cause of the business cycle. After calibrating the model, I find that a large and persistent negative liquidity shock can generate large drops in investment, employment and output. Contrary to the hypothesis, however, a negative liquidity shock generates an equity price boom. This counterfactual response of equity price is robust, provided that a negative liquidity shock tightens firms' financing constraint on investment. Also, I demonstrate that the same counterfactual response of equity price arises when there is a financial shock to a firm's collateral constraint on borrowing. For equity price to fall as it typically does in a recession, the negative liquidity/financial shock must be accompanied or caused by other changes that relax firms' financing constraint on investment. I discuss some candidates of these concurrent changes.

Keywords: Liquidity; Assets; Business cycles; Collateral (search for similar items in EconPapers)
JEL-codes: E32 E5 G1 (search for similar items in EconPapers)
Pages: Unknown pages
Date: 2012-07-03
New Economics Papers: this item is included in nep-bec, nep-dge and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (17)

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Related works:
Journal Article: Liquidity, assets and business cycles (2015) Downloads
Working Paper: Liquidity, Assets and Business Cycles (2011) Downloads
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