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Title: Asset Prices and Business Cycles with Costly External Finance

Author(s): Joao F Gomes, Amir Yaron and Lu Zhang

Publication Date: June 2003

Keyword(s): asset prices, business cycles and financial accelerator

Programme Area(s): Financial Economics and International Macroeconomics

Abstract: This Paper asks whether the asset pricing fluctuations induced by the presence of costly external finance are empirically plausible. To accomplish this, we incorporate costly external finance into a dynamic stochastic general equilibrium model and explore its implications for the properties of the returns on key financial assets, such as stocks, bonds and risky loans. We find that the mean and volatility of the equity premium, although small, are significantly higher than those in comparable adjustment cost models. We also show that these results require a procyclical-financing premium, however, a property that seems at odds with the data.

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Bibliographic Reference

Gomes, J, Yaron, A and Zhang, L. 2003. 'Asset Prices and Business Cycles with Costly External Finance'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=3927