Working Paper: NBER ID: w14205
Authors: Hui Tong; Shangjin Wei
Abstract: We develop a methodology to study whether and how a financial-sector crisis can spill over to the real economy, and apply it to the case of the ongoing subprime mortgage crisis. If there is a spillover, does it manifest itself primarily by reducing consumer confidence and consumer demand? Is there also a supply-side channel through a tightened liquidity constraint faced by non-financial firms? Since most firms appear to have much larger cash holdings than in the past, some suggest that a liquidity constraint is not likely to be a significant factor for non-financial firms. We propose a methodology to estimate the importance of these two channels for spillovers. We first propose an index of a firm's sensitivity to a shock to consumer confidence, based on its response to the 9/11 shock in 2001. We then construct a separate firm-level index on financial constraint based on Whited and Wu (2006). As a robustness check, we also construct an alternative sector-level index of a firm's intrinsic demand for external finance, based on the work of Rajan and Zingales (1998). We find robust evidence suggesting that both channels are at work, but that a tightened liquidity squeeze appears to be economically more important than reduced consumer confidence or spending in explaining cross-firm differences in stock price declines.
Keywords: Subprime Mortgage Crisis; Consumer Confidence; Liquidity Constraints
JEL Codes: G1; G3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Increase in liquidity constraint (E51) | Decline in stock price (G17) |
| Increase in sensitivity to consumer confidence (D12) | Decline in stock price (G17) |
| Higher liquidity constraints and higher sensitivity to demand shocks (E41) | Larger stock price declines (G19) |