Scandinavian Working Papers in Economics

Working Paper Series,
Sveriges Riksbank (Central Bank of Sweden)

No 314: Debt, equity and the Equity price puzzle

Daria Finocchiaro () and Caterina Mendicino ()
Additional contact information
Daria Finocchiaro: Research Department, Central Bank of Sweden, Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden
Caterina Mendicino: Monetary Policy Research, Postal: European Central Bank, Sonnemannstrasse 20, 60314 Frankfurt am Main, Germany;

Abstract: We show that in a model with equity and debt financing, the specfication of the borrowing constraint is crucial to generate empirically plausible responses of macro variables and asset prices to financial shocks. The interaction between financial frictions and labor demand, as in Jermann and Quadrini (2012), is key to the result. A collateral constraint a la Kiyotaki and Moore (1997) augmented with a working capital assumption generates similar results on impact.

Keywords: liquidity shocks; collateral constraints; stock prices; comovement

JEL-codes: E32; E44

19 pages, December 1, 2015

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