Working Paper: NBER ID: w20081
Authors: Francesco Bianchi; Cosmin L. Ilut; Martin Schneider
Abstract: This paper estimates a business cycle model with endogenous financial asset supply and ambiguity averse investors. Firms' shareholders choose not only production and investment, but also capital structure and payout policy subject to financial frictions. An increase in uncertainty about profits lowers stock prices and leads firms to substitute away from debt as well as reduce shareholder payout. This mechanism parsimoniously accounts for postwar comovement in investment, stock prices, leverage and payout, at both business cycle and medium term cycle frequencies. Ambiguity aversion permits a Markov-Switching VAR representation of the model, while preserving the effect of uncertainty shocks on the time variation in the equity premium.
Keywords: Uncertainty; Asset Pricing; Business Cycle; Corporate Finance
JEL Codes: D8; E3; G1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increase in uncertainty about future profits (D89) | lower stock prices (G10) |
| lower stock prices (G10) | firms substitute away from debt (G32) |
| lower stock prices (G10) | reduce shareholder payouts (G35) |
| increase in uncertainty (D89) | decrease in expected profits (L21) |
| uncertainty shocks to MPK and operating costs (D89) | decline in expected profits (L21) |
| uncertainty (D89) | asset pricing dynamics (G19) |