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Financing constraints, irreversibility, and investment dynamics

Caggese, Andrea (2003) Financing constraints, irreversibility, and investment dynamics. Discussion paper, 440. Financial Markets Group, London School of Economics and Political Science, London, UK.

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Abstract

We develop a structural model of an industry with many entrepreneurial firms in order to investigate the cyclical behaviour of aggregate fixed investment, variable capital investment and output. In particular, we consider an environment in which the entrepreneur cannot borrow unless the debt is secured by collateral and cannot sell fixed capital without liquidating her whole business. We show that, when these entrepreneurs experience persistent idiosyncratic and aggregate shocks, the interplay between financing constraints and irreversibility of fixed capital is essential to explain several common observations. It helps to explain why inventory investment is very volatile and procyclical, especially during recessions, and why the output and inventories of small firms are more volatile and more cyclical than that of large firms. The model is also consistent with the observations that inventory investment leads the business cycle, and that both fixed and inventory investment are sensitive to the net worth of firms, even when marginal productivity of capital is taken into account.

Item Type: Monograph (Discussion Paper)
Official URL: http://fmg.lse.ac.uk
Additional Information: © 2003 The Author
Library of Congress subject classification: H Social Sciences > HG Finance
H Social Sciences > HB Economic Theory
Sets: Research centres and groups > Financial Markets Group (FMG)
Collections > Economists Online
Collections > LSE Financial Markets Group (FMG) Working Papers
Rights: http://www.lse.ac.uk/library/usingTheLibrary/academicSupport/OA/depositYourResearch.aspx
Identification Number: 440
Date Deposited: 12 Aug 2009 10:56
URL: http://eprints.lse.ac.uk/24828/

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