Abstract
The central variable of theories of financial frictions - the external finance premium - is unobservable. This paper distils the external finance premium from a DSGE model estimated on US macroeconomic data. Within the DSGE framework, movements in the premium can be given an interpretation in terms of shocks driving business cycles. A key result is that the estimate - based solely on non-financial macroeconomic data - picks up over 70% of the dynamics of lower grade corporate bond spreads. The paper also identifies a gain in fitting key macroeconomic aggregates by including financial frictions in the model and documents how shock transmission is affected.
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