Working Paper: NBER ID: w19204
Authors: Andrew G. Atkeson; Andrea L. Eisfeldt; Pierre-Olivier Weill
Abstract: Building on the Merton (1974) and Leland (1994) structural models of credit risk, we develop a simple, transparent, and robust method for measuring the financial soundness of individual firms using data on their equity volatility. We use this method to retrace quantitatively the history of firms' financial soundness during U.S. business cycles over most of the last century. We highlight three main findings. First, the three worst recessions between 1926 and 2012 coincided with insolvency crises, but other recessions did not. Second, fluctuations in asset volatility appear to drive variation in firms' financial soundness. Finally, the financial soundness of financial firms largely resembles that of nonfinancial firms.
Keywords: financial soundness; distance to insolvency; equity volatility; business cycles; insolvency crises
JEL Codes: E32; E44; G3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Largest US recessions (1932-1933, 1937, and 2008) (N12) | insolvency crises (G33) |
| Changes in DI during the 2008 crisis (F44) | driven by asset volatility (G19) |
| Changes in DI during the 2008 crisis (F44) | not driven by leverage (G19) |
| DI of financial firms (G24) | DI of nonfinancial firms (G32) |
| DI of financial firms (G24) | systemic risk is similar across sectors (P34) |