Research Discussion Papers, Bank of Finland
No 26/2014:
The net worth trap: investment and output dynamics in the presence of financing constraints
Jukka Isohätälä, Alistair Milne ()
and Donald Robertson
Abstract: We study the impact of fi nancing constraints on
investment and output dynamics, in a continuous time setting with output a
linear function of capital. Decline of net worth reduces investment and, if
fi rms can rent capital to unconstrained outside investors, can create a
'net worth trap' with both investment and output falling below normal
levels for long time periods. We provide a detailed account of our model
solution and discuss both the economic intuition underpinning our results
and the implications for macroeconomic modeling.
Keywords: cash flow management; corporate prudential risk; the financial accelerator; financial distress; induced risk aversion; liquidity constraints; liquidity risk; (follow links to similar papers)
JEL-Codes: E44; (follow links to similar papers)
51 pages, November 6, 2014
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