Dynamic Asset Pricing with Interactions between Short-Sale and Borrowing Constraints

This paper studies the joint effect of borrowing and short-sale constraints under heterogeneous beliefs and risk aversions. Although the constraints never simultaneously bind in equilibrium, interesting economics emerge in the anticipatory effects of potentially future binding constraints. In particular, the risk-free rate and Sharpe ratio experience endogenous jumps at a critical state, where two equilibria coexist. Moreover, a short-sale ban can lead to a lower stock price and higher volatility depending on the relative tightness between the constraints, and tightening the borrowing constraint during a short-sale ban can also make returns more volatile.

Anatomy of Corporate Borrowing Constraints*

Macro-finance analyses commonly link firms’ borrowing constraints to the liquidation value of physical assets. For U.S. nonfinancial firms, we show that 20% of debt by value is based on such assets (asset-based lending in creditor parlance), whereas 80% is based predominantly on cash flows from firms’ operations (cash flow–based lending). A standard borrowing constraint restricts total debt as a function of cash flows measured using operating earnings (earnings-based borrowing constraints). These features shape firm outcomes on the margin: first, cash flows in the form of operating earnings can directly relax borrowing constraints; second, firms are less vulnerable to collateral damage from asset price declines, and fire sale amplification may be mitigated. Taken together, our findings point to new venues for modeling firms’ borrowing constraints in macro-finance studies.

Financial Integration, Savings Gluts, and Asset Price Booms

Capital outflows after financial integration can lead to simultaneous increases in the national savings rate and asset prices of an economy with substantial financing costs. Under autarky, firms invest in risky capital while facing a borrowing constraint that creates a need for precautionary savings. Financial integration provides firms with access to foreign risk-free assets and results in two effects: a substitution effect, whereby firms divert some investments to foreign assets and cause capital outflows; and a wealth effect, whereby they grow richer in equilibrium and thus demand more domestic capital. Savings gluts and asset price booms occur when the wealth effect dominates.

UNSECURED CREDIT, PRODUCT VARIETY, AND UNEMPLOYMENT DYNAMICS

Revolving credit is the prime determinant of short-run household liquidity and comoves positively with product variety and negatively with unemployment. I develop a theory of feedback between revolving credit and product development and examine its ability to explain labor market volatility. Extending the Mortensen–Pissarides model with an endogenous borrowing constraint and free entry of monopolistically competitive firms reproduces stylized facts in the data and amplifies both productivity and financial shocks through mutual causality. Higher debt limits encourage firm entry and raise product variety (the entry channel), and greater variety makes default more costly and thereby raises the equilibrium debt level (the consumption value channel). Though productivity shocks are sufficient to generate higher volatility, financial shocks are essential in approximating the time series patterns of unemployment, vacancies, and revolving credit in the data, and reproduce the rise in unemployment during the Great Recession.

Dynamic effects of consumption tax reforms with durable consumption

This paper introduces durables into a dynamic general equilibrium overlapping generation model with idiosyncratic income shocks and endogenous borrowing constraints, which depend on durables. The aim of this paper is to evaluate the welfare effects of consumption tax reforms in a richer model that captures the difference between nondurable and durable consumption. When durables are considered, the standard results that a shift to consumption taxes is welfare improving are overturned. The mechanism of this opposing result is that consumption tax makes durable consumption more expensive without relaxing the borrowing constraint. The inability of borrowing to insure against income risk deviates the economy further away from market completeness and particularly hurts young and poor households. As a result, welfare decreases, coupled with negative redistribution.