The Net Worth Trap: Investment and Output Dynamics in the Presence of Financing Constraints
51 Pages Posted: 26 Apr 2016
Date Written: 2014
Abstract
We study the impact of financing 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 firms 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, financial accelerator, financial distress, induced risk aversion, liquidity constraints, liquidity risk, macroeconomic propagation, multiperiod financial management, non-linear macroeconomic modelling, Tobin's q, precautionary savings
Keywords: E44
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