External Equity Financing Shocks, Financial Flows, and Asset Prices
NBER Working Paper No. 20210
The ability of corporations to finance its operations by issuing new equity varies with macroeconomic conditions, because the time varying macroeconomic conditions affect investors' (or workers') willingness to pay for new equity. We document that an empirical proxy of the shocks to the cost of equity issuance captures systematic risk in the economy, even controlling for the impact of aggregate productivity (or stock market) shocks. Exposure to this shock helps price the cross section of stock returns including book-to-market, size, investment, debt growth, and issuance portfolios. We then propose a dynamic investment-based model that features an aggregate shock to the firms' cost of external equity issuance, and a collateral constraint. Our central finding is that time- varying external financing costs are important for the model to quantitatively capture the joint dynamics of firms' real quantities, financing flows, and asset prices. Furthermore, the model also replicates the failure of the unconditional CAPM in pricing the cross-sectional expected returns.
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Document Object Identifier (DOI): 10.3386/w20210
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