Working Paper

Capital Allocation and Investment Dynamics in Credit Crises (May 2018)
Previous title: Corporate Debt Structure, Precautionary Savings, and Investment Dynamics
[Full Paper][Main Text][Appendix]

During the Great Recession, the less financially constrained firms that increased borrowing from the market actually experienced a steeper decline in investment than the more financially constrained firms. In an incomplete-market model, I introduce a precautionary savings motive for firms to explain the divergence of borrowing from investment that standard firm investment models miss. When uncertainty is slow to resolve during a credit crisis, the opportunity to reallocate portfolio from capital to risk-free asset in the midst of high uncertainty incentivizes firms to increase borrowing at the beginning of the crisis. The model can account for the large accumulation of both debt and cash holdings in periods of low interest rates and high uncertainties. The precautionary savings channel greatly contributes to the slow recovery in the aftermath of the recession. Adding debt structure to the model, firms take larger debt positions and the effect of a credit crisis can be larger and more persistent.


Work in Progress

Noisy Financing and Investment Waves (with Antonio Falato)