Default Rate and Price of Capital in a Costly External Finance Model

  • Juan Pablo Medina Central Bank of Chile

Abstract

Financial frictions have been used to enrich mechanisms transmission in macroeconomics. However, the predictions of real business cycle models of costly external finance imply a procyclical default rate, external premium and relative price of capital which seems at odds with the data. In this article, we include technology shocks that affect the average productivity and idiosyncratic risk of capital producers in a standard costly external finance model. These elements enhance the model to deliver a countercyclical default rate, external finance and relative price of capital premium which are more consistent with the data and contrary to the results obtained with a sector-neutral productivity shock. Intuitively, if the entrepreneurs’ investment projects become more productive in average, the relative price of capital and the default rate fall while investment and output increase. Using data on the relative price of capital, we perform a calibration of this type of shocks which highlights its business-cycle relevance.
Published
2010-03-02
How to Cite
Medina, J. P. (2010). Default Rate and Price of Capital in a Costly External Finance Model. Economic Analysis Review, 21(1), 3-28. Retrieved from https://www.rae-ear.org/index.php/rae/article/view/52
Section
Articles