Heterogeneous Firms and Credit Risk
Friday, Jan. 4, 2019 8:00 AM - 10:00 AM
- Chair: Giulio Seccia, Nazarbayev University
Sovereign Default Risk and Firm Heterogeneity
AbstractThis paper studies the recessionary effects of sovereign default risk using firm-level data and a model of sovereign debt with firm heterogeneity. Our environment features a two-way feedback loop. Low output decreases the tax revenues of the government and raises the risk that it will default on its debt. The associated increase in sovereign interest rate spreads, in turn, raises the interest rates paid by firms, which further depresses their production. Importantly, these effects are not homogeneous across firms, as interest rate hikes have more severe consequences for firms that are in need of borrowing. Our approach consists of using these cross-sectional implications of the model, together with micro data, to measure the effects that sovereign risk has on real economic activity. In an application to Italy, we find that the progressive heightening of sovereign risk during the recent crisis was responsible for 50% of the observed decline in output.
Default Risk and Aggregate Fluctuations in an Economy with Production Heterogeneity
AbstractWe study aggregate fluctuations in an economy where firms have persistent differences in total factor productivities, capital and debt or financial assets. Investment is funded by retained earnings and non-contingent debt. Firms may default upon loans, and this risk leads to a unit cost of borrowing that rises with the level of debt and falls with the value of collateral. On average, larger firms, those with more collateral, have higher levels of investment than smaller firms with less collateral. Since large and small firms draw from the same productivity distribution, this implies an insufficient allocation of capital in small firms and thus reduces aggregate total factor productivity, capital and GDP. We consider business cycles driven by shocks to aggregate total factor productivity and by credit shocks. The latter are financial shocks that worsen firms' cash on hand. In equilibrium, our nonlinear loan rate schedules drive countercyclical default risk and exit. Because a negative productivity shock raises default probabilities, it leads to a modest reduction in the number of firms and a deterioration in the allocation of capital that amplifies the effect of the shock. The recession following a negative credit shock is qualitatively different from that following a productivity shock, and more closely resembles the 2007 U.S. recession in several respects. A rise in default and a substantial fall in entry yield a large decline in the number of firms. Measured TFP falls for several periods, as do employment, investment and GDP, and the ultimate declines in investment and employment are large relative to that in TFP. Moreover, the recovery following a credit shock is gradual given slow recoveries in TFP, aggregate capital, and the measure of firms.
The Role of Trade Credit and Bankruptcy in Business Fluctuations
AbstractGiven the fact that trade credit is the most important source of short-term firms' credit, we build a quantitative general equilibrium heterogeneous firms model to assess the contribution of trade credit delinquency to observed fluctuations in bankruptcies, GDP and employment. In the model, an intermediate good is purchased by final-good producers on trade credit before observing the realisation of their productivity. A bad productivity shock may ex-post induce final-good producers not to pay suppliers or, alternatively, liquidate via bankruptcy. Aggregate delinquency risk is taken into account by input suppliers; the individual liquidation risk is priced in by lenders supplying bank credit. We characterize firm-level patterns of trade credit delinquency, focusing on its association with bankruptcy risk, indebtedness and size within the distribution of firms. The model delivers levels of trade-credit delinquency and bankruptcy comparable with the data. Within an individual firm, delinquency most often precedes, though it is not necessary for, bankruptcy. Delinquency may mitigate bankruptcies as it provides an alternative option for dealing with financial constraints. We use the model to study the response to aggregate shocks.
- E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy
- G1 - General Financial Markets