Aggregate Leverage Research Articles

Leverage and productivity

This paper argues that earnings-based borrowing is important for understanding the extent to which financial frictions lower aggregate productivity (TFP). It builds a general equilibrium model of misallocation due to financial frictions wherein firms borrow by pledging assets and earnings. The model is disciplined to match evidence on aggregate leverage and on the firm-level relationship between leverage and the output-to-capital ratio. Conditional on aggregate leverage, the TFP loss from financial frictions shrinks with the pledgeability of earnings. Similarly, for a given difference in aggregate leverage between two countries, financial frictions may contribute significantly more to TFP differences when the poorer country has lower pledgeability of earnings.

Modeling the aggregate risk of common stockholder through the determined financial model

Subject. The article focuses on methods for modeling and quantifying the risk associated with common stockholders. Objectives. We perform a critical analysis and study how the existing risk assessment methods can be modified. The article demonstrates strengths and advantages of the determined financial model. Methods. The study is based on methods of the discourse analysis, mathematical statistics, financial modeling. Results. If the entity receives payments out of net profit, we show the modified formula for assessing the aggregate leverage and suggest using the term financial leverage in Russian. The chi-squared comparison method reveals the need to respect aggregate leverage restrictions. We also present formulae for assessing its minimum and maximum. In this study, we provide a broader view of the financial mentality as a concept, quantify to what extent the decision-maker is prone to risk. Conclusions and Relevance. The advisable aggregate leverage fits in the interval, which should be specifically assessed for each entity, and can be determined by official reporting data through the proposed formulae. Managing common stockholders’ risk pursues to maintain the aggregate leverage ratio within its maximum and minimum. This task can be solved by modifying the structure and ratio of fixed and variable costs.

To what extent does aggregate leverage determine financial fragility? New insights from an agent-based stock-flow consistent model

To what extent does aggregate leverage determine financial fragility? New insights from an agent-based stock-flow consistent model

THE EFFECT OF CONSUMER CONFIDENCE ON AGGREGATE HOUSEHOLD CONSUMPTION AND LEVERAGE

Consumer confidence measures and their effects on macroeconomic variables have been subject to extensive research since it was devised in the 1940s. Some empirical studies suggest that it is one of the leading causes of macroeconomic fluctuations through its effects on household consumption. Particularly, consumer durables spending and household borrowing are found to be sensitive to consumer confidence. In this study, a stock-flow-consistent system dynamics model is developed to explain how consumer confidence affects the aggregate household behavior and the macroeconomic dynamics of the economy. The simulation results confirm that consumer confidence strongly affects the economy's dynamic behavior. It is shown that the psychological and structural parameters determine the stability properties of the economy.

How stable are corporate capital structures? International evidence

Abstract Using a large sample of firms from 43 markets, we find significant time-series variation in firms’ leverage ratios around the world. Industry median leverage ratios and aggregate leverage ratios also change substantially over time. Relative to actual leverage ratios, target leverage ratios estimated from the time-varying target models are much more stable. Variance decomposition shows that leverage instability is largely driven by deviations from the target. A number of firm and market characteristics are related to capital structure instability. We also find evidence consistent with firms using financing activities to adjust their leverage ratios towards the target in global markets.

How Stable Are Corporate Capital Structures? International Evidence

Using a large sample of firms from 43 markets, we find significant time-series variations in firms’ leverage ratios around the world. Industry median leverage ratios and aggregate leverage ratios also change substantially over time. Relative to actual leverage ratios, target leverage ratios estimated from the time-varying target models are much more stable. Variance decomposition shows that leverage instability is largely driven by deviations from the target. A number of firm and market characteristics are related to capital structure instability. We also find evidence consistent with firms using financing activities to adjust their leverage ratios towards the target in global markets.

Bank Runs, Fragility, and Credit Easing

We present a tractable dynamic macroeconomic model of self-fulfilling bank runs. A bank is vulnerable to a run when a loss of investors' confidence triggers deposit withdrawals and leads the bank to default on its obligations. We analytically characterize how the vulnerability of an individual bank depends on macroeconomic aggregates and how the number of banks facing a run affects macroeconomic aggregates in turn. In general equilibrium, runs can be partial or complete, depending on aggregate leverage and the dynamics of asset prices. Our normative analysis shows that the effectiveness of credit easing and its welfare implications depend on whether a financial crisis is driven by fundamentals or by self-fulfilling runs.

Firms’ Leverage Across Business Cycles

Based on a large sample of mostly unlisted non-financial companies, this paper studies the relationship between business cycles and firms’ leverage, disentangling the relative contributions of debt and equity and assessing the role of firm size in explaining cross-sectional heterogeneity. I find that aggregate leverage initially increases during busts, as debt growth remains steady, while the counterbalancing contribution of equity is smaller; after one year, as debt slows down, leverage decreases. Moreover, firm size matters, also after controlling for other proxies of financial frictions (age, risk, profitability, debt structure): leverage increases more at the beginning of busts for both very large and smaller firms; after one year, leverage decreases less for the latter, mainly due to persistently lower profits.

Financial intermediation, house prices, and the welfare effects of the U.S. Great Recession

Abstract This paper quantifies the welfare costs of the Great Recession in the United States and their distribution between borrowing and saving households. We use a calibrated dynamic general equilibrium model with shocks to aggregate income and to the financial intermediation sector. The model matches the boom-bust cycle in house prices, the dynamics of household leverage, and the increase in inequality of wealth observed in the U.S. after 2007. We find large welfare costs for financially constrained households, the borrowers. Savers instead benefited from a redistribution of housing wealth due to the de-leveraging of borrowers caused by the plunge in house prices. This redistribution mechanism was exacerbated by the financial intermediation shock. We also show that the welfare costs for borrowers would have been lower if aggregate leverage had remained at pre-2001 levels.

Shadow banking and optimal capital requirements

This paper studies optimal time-varying capital requirements in a general equilibrium model with two types of financial intermediaries: regulated commercial banks (CBs) and unregulated shadow banks (SBs). Subject to capital regulation, each CB faces higher cost of funds and requires higher lending interest rate when it lends more to the borrower. The borrower internalizes this effect and chooses a lower leverage ratio when financing with a CB than when financing with an unregulated SB. Tightening the capital requirement reduces the credit supply within the CB sector but may stimulate total borrowings through an extensive-margin effect, as more borrowers choose high-leverage SB finance over low-leverage CB finance and the aggregate leverage ratio of all borrowers increases. If the extensive-margin effect outweighs the intensive-margin effect, tightening capital requirement will be expansionary and optimal capital requirements will become countercyclical.

Bank-specific shocks and aggregate leverage: Empirical evidence from a panel of developed countries

This paper investigates the link between shocks in the banking sector and aggregate leverage measured by the credit-to-GDP gap. Using a balanced panel of 15 countries for the period 1989–2016, we exploit the approach due to Gabaix (2011) and consider banking granular shocks as an indicator of banking distress. Using methods that account for potential endogeneity, we find that banking shocks Granger-cause aggregate leverage. In particular, banking shocks tend to increase the level of leverage and cause departures of the credit-to-GDP ratio from its long-term trend.

An Endogenous Approach to the Cyclicality of R&D Investment under Credit Constraints: Firms’ Cash Flow Matters!

This paper examines the sensitivity of firms’ R&D expenditures to being externally financial constrained to undertake innovation projects, considering that being constrained is endogenous. It focuses on devising a model that enable us to explore the combined impact of liquidity constraints, demand shocks, and credit cycle on the cyclically of R&D, controlling by the firms characteristics. The methodology proposed consists of jointly estimating three interrelated equations with mixed distributions of dependent variables. The results obtained complete and improve those of the previous research. It is found that the effect of the business cycle on the perception of external financial constraints is subject to the availability of internal funds in each firm. On the other hand, constrained firms expend in R&D halve of the unconstrained ones, and the sensitivity of firms’ R&D expending to GDP is countercyclical in firms with low cash flows and procyclical in firms with high cash flows. The R&D expending of firms is negatively associated with the aggregate leverage ratio of the non-financial sector. These results mean that business decisions, in particular R&D expending decisions, and macroeconomic variables are strongly related. A better understanding of these interrelations should help in designing macroeconomic policies aimed at stabilizing the economy and reduce growth volatility.

Firms’ leverage ratio and the Financial Instability Hypothesis: an empirical investigation for the US economy (1970–2014)

Abstract‘There are many ‘Minskian’ interpretations of how financial fragility builds up reflecting the unsolved tensions regarding the transition from micro to macro results in Minsky’s Financial Instability Hypothesis (FIH).’ Using firm-level and macroeconomic data to comply with the variety of FIH’s interpretations, we empirically assess the relations between leverage and financial fragility in the US economy (1970–2014). To evaluate firms’ financial fragility, we deploy Minsky’s scale—from the financially sounder to the more fragile firms: hedge, speculative and Ponzi. The main findings are the following: (i) the evolution of the aggregate leverage ratio does not account for the systemic financial fragility, measured by the frequency of speculative and Ponzi firms, and (ii) within the biggest firms, the leverage has increased along with the incidence of hedge financing, and for the smallest firms group the opposite has happened. We conclude that a positive relation between leverage and financial fragility cannot be deemed to be a general outcome.

Economic Uncertainty, Aggregate Debt, and the Real Effects of Corporate Finance

To explore the real effects of corporate leverage on aggregate risk and welfare, I develop a tractable general equilibrium model with endogenous capital structure driven by time-varying economic uncertainty. Fitting the model leads to interesting insights as to the shortcomings of the standard paradigm. Contrary to the trade-off version, the empirical relation between uncertainty and aggregate leverage is positive. This association is not attributable to supply-side constraints or adjustment costs. An alternative formulation in which debt incentives rise with uncertainty can account for the observed dynamics of uncertainty, credit spreads and leverage. This version, unlike the trade-off model, implies that the real effects of debt on the equilibrium can become severely negative.

Heterogeneous Intermediaries and Asset Prices

Canonical intermediary asset pricing models assume a representative intermediary with an SDF linear in its leverage. Yet the leverage of broker-dealers is procyclical whereas the leverage of banking holding companies is countercyclical. I propose an empirically testable heterogeneous intermediary stochastic discount factor (HI-SDF) that depends non-linearly on aggregate leverage as well as net worth shares of individual intermediaries. I show that the HI-SDF emerges from general equilibrium models with heterogeneous intermediaries whereas its specific functional form hinges on different models' specifications of financing constraints. To address this issue, the HI-SDF is estimated semiparametrically. I provide empirical evidence that the wealth distribution among intermediaries is an important source of risk for pricing risky securities. The estimated HI-SDF is found to exhibit substantial explanatory power for cross-sectional variation in expected returns across a wide range of test assets. In contrast to representative intermediary empirical models, the HI-SDF exhibits lower pricing errors and explains larger fractions of the cross-section of expected returns.

Identifying excessive credit growth and leverage

Unsustainable credit developments lead to the build-up of systemic risks to financial stability. While this is an accepted truth, how to assess whether risks are getting out of hand remains a challenge. To identify excessive credit growth and aggregate leverage we propose an early warning system, which aims at predicting banking crises. In particular, we use a modern classification tree ensemble technique, the “Random Forest”, and include (global) credit as well as real estate variables as predictors.

Empirical Studies on Corporate Capital Structure in Vietnam

The purpose of the study is to examine the influence of firm characteristics (profitability, investment opportunity “market-to-book ratio”, tangibility, size, growth) and industry effect to capital structure of stock companies in Vietnam. The study uses OLS regression method to analyze a data set consisting of 522 non-financial companies listed in the two stock exchanges Ho Chi Minh Stock Exchange (HSX) and Ha Noi Stock Exchange (HNX) during the period from 2008 to 2011. The aggregate market-based leverage ratio in Vietnam is about 0.29. Despite the differences in business environment and management, this ratio is consistent to the statement from Frank and Goyal (2007) “Over the past half century the aggregate market-based leverage ratio has been about 0.32”. The empirical results show that profitability, tangibility, and growth are the major three determinants to debt ratios. The strong negative correlation between profitability and all debt ratios supports the prediction of the pecking order theory and it is considered as a serious defect of the trade-off theory. Tangibility has a strong positive correlation with long-term debt ratio but it has a negative correlation with short-term debt ratio. This result is consistent with the maturity mismatch principle “Firms tend to use long-term debt to finance fixed assets to prevent maturity mismatch; consequently, firms with high fraction of tangibility are expected to have high long-term debt ratio but low short-term debt ratio”. The strong positive correlation between growth and all debt ratios is consistent to the statement of Jensen and Meckling, 1976 “Debt disciplines managers and mitigates agency problems to free cash flow since debt must be repaid to avoid bankruptcy”. However, the fact that firms that have cash on hand actually issue debts is considered a serious problem of the pecking order theory (Frank and Goyal, 2007). As per the empirical results the corporate capital structure of the whole data is dominated by short-term debt, but the corporate capital structure at industry level is sometimes dominated by long-term debt. It is consistent with the result of Gilson (1997) “Industry leverage is used as a proxy for target capital structure”. According to Hovakimian et al. (2001), firms actively adjust their debt ratios towards the industry average. And similar persistence at firm level is reported in Lemmon et al. (2007). The differences of corporate capital structure at industry level and the similar persistence of capital structure at firm level reflect the role of industry effect as the crucial determinant of the target debt ratios.

Does Size Matter? Bailouts with Large and Small Banks

We explore how large and small banks make funding decisions when the government provides system-wide bailouts to the financial sector. We show that bank size, purely on strategic grounds, is a key determinant of banks' leverage choices, even when bailout policies treat large and small banks symmetrically. Large banks always take on more leverage than small banks because they internalize that their decisions directly affect the government's optimal bailout policy. In equilibrium, small banks also choose strictly higher borrowing when large banks are present, since banks' leverage choices are strategic complements. Overall, the presence of large banks increases aggregate leverage and the magnitude of bailouts. The optimal ex-ante regulation features size-dependent policies that disproportionally restrict the leverage choices of large banks. A quantitative assessment of our model implies that an increase in the share of assets held by the five largest banks from 50% to 70% is associated with a 3.5 percentage point increase in aggregate debt-to-asset ratios (from 90.1% to 93.6%). Under the optimal policy, large banks face a “size tax” of 40 basis points (0.4%) per dollar of debt issued.

The Leveraging of Corporate America: A Long‐Run Perspective on Changes in Capital Structure

In a study published recently in the Journal of Financial Economics, the authors of this article documented a substantial increase in the use of debt financing by U.S. companies over the past century. From 1920 until the mid‐1940s, the aggregate leverage of unregulated U.S. companies was low and stable, with the average debt‐to‐capital ratio staying within the narrow range of 10% to 15%. But during the next 25 years, the use of debt by U.S. companies more than doubled, rising to 35% of total capital. And since 1970, aggregate leverage has remained above 35%, peaking at 47% in 1992. Moreover, this pattern has been observed in companies of all sizes and operating in all unregulated sectors.Changes in the characteristics of U.S. public companies during this period provide little help in explaining the increase in corporate leverage. For example, the displacement of tangible by intangible assets in many sectors of the U.S. economy during the past 50 years would have led most economists to predict, holding all other things equal, a reduction rather than an increase in aggregate corporate leverage. Instead, according to the authors' findings, the main contributors to the increases in U.S. corporate leverage since the 1940s have been external changes, including increases in corporate income tax rates, the development of financial markets and intermediaries, and the reduction in government borrowing in the decades following World War II. The authors' analysis also identifies these last two changes—the development of financial markets, including the rise of institutional investors and shareholder activism, and the post‐War reduction in government debt—as having played the biggest roles in the leveraging of corporate America.

Financial Intermediation, Leverage, and Macroeconomic Instability

This paper investigates how financial sector leverage affects macroeconomic instability and welfare. In the model, banks borrow (use leverage) to allocate resources to productive projects and pro vide liquidity. When banks do not actively issue new equity, aggregate outcomes depend on the level of equity in the financial sector. Equilibrium is inefficient because agents do not internalize how their decisions affect volatility, aggregate leverage, and the returns on assets. Leverage creates systemic risk, which increases the frequency and duration of crises. Limiting leverage decreases asset price volatility and increases expected returns, which decrease the likelihood that the financial sector is undercapitalized. (JEL E32, E44, G01, G21)