Sticky Leverage

2016 ◽  
Vol 106 (12) ◽  
pp. 3800-3828 ◽  
Author(s):  
João Gomes ◽  
Urban Jermann ◽  
Lukas Schmid
Keyword(s):  
Interest Rate ◽  
General Equilibrium ◽  
Equilibrium Model ◽  
Debt Maturity ◽  
General Equilibrium Model ◽  
Corporate Debt ◽  
Debt Overhang ◽  
The Real ◽  
Unanticipated Inflation

We develop a tractable general equilibrium model that captures the interplay between nominal long-term corporate debt, inflation, and real aggregates. We show that unanticipated inflation changes the real burden of debt and, more significantly, leads to a debt overhang that distorts future investment and production decisions. For these effects to be both large and very persistent, it is essential that debt maturity exceeds one period. We also show that interest rate rules can help stabilize our economy. (JEL E12, E31, E44, E52, G01, G32, G35)

scholarly journals The Real Options Solution To A Cost-Of-Capital Dilemma

2010 ◽  
Vol 8 (2) ◽  
Author(s):  
David Eagle ◽  
David L. Senteney ◽  
Dean Kiefer ◽  
Arsen Djatej
Keyword(s):  
General Equilibrium ◽  
Real Options ◽  
Equilibrium Model ◽  
Cost Of Capital ◽  
General Equilibrium Model ◽  
Rate Of Return ◽  
Expected Returns ◽  
Font Size ◽  
Expected Return ◽  
The Real

<p class="MsoNormal" style="text-align: justify; margin: 0in 0.5in 0pt; mso-pagination: none;"><span style="color: #0d0d0d; font-size: 10pt; mso-themecolor: text1; mso-themetint: 242;"><span style="font-family: Times New Roman;">The required rate of return should equal the average expected return in the market for the same level of risk.<span style="mso-spacerun: yes;">&nbsp; </span>However, firms should only accept such projects with expected returns that <span style="text-decoration: underline;">exceed</span> this required rate of return.<span style="mso-spacerun: yes;">&nbsp; </span>This contradicts our first statement that the required rate of return <span style="text-decoration: underline;">equals</span> this average expected return for the market.<span style="mso-spacerun: yes;">&nbsp; </span>We study this possible paradox in the context of a stochastic general-equilibrium model with endogenous prices.<span style="mso-spacerun: yes;">&nbsp; </span>We find that the capitalization of the real options involved in this model explains away this contradiction or paradox.</span></span></p>

Comments on "Shadow Pricing and Macroeconomic Analysis: Some Illustrations from Pakistan" by Squire et al.

1979 ◽  
Vol 18 (2) ◽  
pp. 113-115
Author(s):  
T. N. Srinivasan
Keyword(s):  
General Equilibrium ◽  
Equilibrium Model ◽  
General Equilibrium Model ◽  
Equilibrium Analysis ◽  
Partial Equilibrium ◽  
Shadow Prices ◽  
Essential Point ◽  
Economic Issues ◽  
Shadow Pricing ◽  
Extreme Sensitivity

The paper is too long for conveying the message that shadow pricing used as a method of analysis in micro-economic issues of project selection is also useful for analysing macro-economic issues, such as foreign and domestic borrowing by the government, emigration, etc. Much of the methodological discussion in the paper is available in a readily accessible form in several publications of each of the coauthors; In contrast, the specific application of the methodology to Pakistani problems is much too cavalier. While it is hard to disagree with the authors' claim that shadow pricing "constitutes a relatively informal attempt to capture general equilibrium effects" (p. 89, emphasis added), their depiction of traditional analysis is a bit of a caricature: essentially it sets up a strawman to knock down. After all in the traditional partial equilibrium analysis, the caveat is always entered that the results are possibly sensitive to violation of the ceteris paribus assumptions of the analysis, though often the analysts will claim that extreme sensitivity is unlikely. Analogously, the shadow pricing method presumes "stationarity" of shadow prices in the sense that they are “independent of policy changes under review" (p. 90). The essential point to be noted is that the validity of this assertion or of the "not too extreme sensitivity" assertion of partial equilibrium analysts can be tested only with a full scale general equilibrium model! At any rate this reviewer would not pose the issue as one of traditional partial equilibrium macro-analysis versus shadow pricing as an approximate general equilibrium analysis, but would prefer a description of project analysis as an approach in which a macro-general equilibrium model of a manageable size (implicit or explicit) is used to derive a set of key shadow prices which are then used in a detailed micro-analysis of projects.

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