Financial Development, Long-Term Finance and the Macroeconomy: The Role of Secondary Markets

Abstract

The paper develops a dynamic general equilibrium model of financial markets and macroeconomy. In the model, long-term debt is extended to firms in a primary market and then traded in a secondary market among financiers. Two financial frictions that are ex-ante and ex-post with respect to the secondary market trading date raise the cost of debt finance. In stationary equilibrium, while ex-ante frictions are always counterproductive, financing costs that are ex-post could promote macroeconomic growth. I show that a model consistent with the U.S. financial development experience of the last 30 years is likely to exhibit declining ex-post frictions.

Keywords: microfoundations of financial frictions, long-term investment, and secondary

JEL Classification: E44, G2, O16, O47