DP3927 Asset Prices and Business Cycles with Costly External Finance

Author(s): Joao F Gomes, Amir Yaron, Lu Zhang
Publication Date: June 2003
Keyword(s): asset prices, business cycles, financial accelerator
JEL(s): E22, E44, G31
Programme Areas: International Macroeconomics, Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3927

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.