Why does the Cost of Credit Intermediation Increase for Small Firms Relative to Large Firms during Recessions? A Conceptual and Empirical Analysis

Miguel Ramirez and Aalok Pandey ()
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Aalok Pandey: Department of Economics, Trinity College

No 1205, Working Papers from Trinity College, Department of Economics

Abstract: The Great Recession of 2007-09 has had a devastating and long-lasting effect on the US economy. New Institutional Theories (NIT) of finance contend that part of the explanation for the amplification and duration of economic recessions resides in the presence of asymmetric information and market imperfections in the credit market. During recessions, smaller firms without established credit records and low net worth find that access to credit is, at best, limited and very costly. These firms are forced to cut back on their investment and consumption spending which, in turn, exacerbates the recession via a downward spiral of self-reinforcing effects. Following the lead of Walker (2010), this paper estimates a Vector Error Correction Model (VECM) that incorporates economic and financial factors that affect the cost of credit intermediation for small and large firms during the 1998-2011 period. It also examines the impact of recession on these factors as well as the prices that firms pay for access to credit. The reported estimates suggest that the impact of economic recession on the cost of credit intermediation was significant. The results also indicate that the cost of credit intermediation decreases in a recession; however, the decrease is more pronounced in the case of large firms as compared to small firms.

Keywords: Asymmetric information; adverse selection; cointegration; Credit Rationing Model; Financial Accelerator Model; moral hazard; recession; and Vector Error Correction Model (VECM). (search for similar items in EconPapers)
JEL-codes: C22 D82 E44 G02 (search for similar items in EconPapers)
Pages: 34 pages
Date: 2012-07
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Citations: View citations in EconPapers (1)

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http://www3.trincoll.edu/repec/WorkingPapers2012/WP12-05.pdf First version, 2012 (application/pdf)

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Persistent link: https://EconPapers.repec.org/RePEc:tri:wpaper:1205

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