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Uncertainty Shocks and Corporate Borrowing Constraints

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  • Ahmed Kamara

    (College of Business, Texas A&M University-Corpus Christi, 6300 Ocean Drive, Corpus Christi, TX 78412, USA)

  • Niraj P. Koirala

    (Department of Economics and Statistics, California State University Los Angeles, 5154 State University Dr, Los Angeles, CA 90032, USA)

Abstract

In this paper, we study the effects of uncertainty shocks in a quantitative framework where firms in the corporate sector are constrained by credit. Specifically, we formulate borrowing constraints as a nested function that features both earnings and capital as alternative instruments for assessing credit worthiness, in line with recent trends in corporate finance. We find that the quantitative framework that incorporates only one instrument (capital or earnings) in the borrowing constraint falls short in matching the business cycle properties of the US economy in terms of the behavior of output, inflation, and the price markup which are an essential part of the literature on uncertainty shocks. Rather, a hybrid formulation of the borrowing constraint which accounts for both capital and earnings helps us bring the results in the quantitative model closer to the data.

Suggested Citation

  • Ahmed Kamara & Niraj P. Koirala, 2023. "Uncertainty Shocks and Corporate Borrowing Constraints," IJFS, MDPI, vol. 11(1), pages 1-35, January.
    • Handle: RePEc:gam:jijfss:v:11:y:2023:i:1:p:21-:d:1041499
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    References listed on IDEAS

    as
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    3. Ben S. Bernanke, 1983. "Irreversibility, Uncertainty, and Cyclical Investment," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 98(1), pages 85-106.
    4. Bordo, Michael D. & Duca, John V. & Koch, Christoffer, 2016. "Economic policy uncertainty and the credit channel: Aggregate and bank level U.S. evidence over several decades," Journal of Financial Stability, Elsevier, vol. 26(C), pages 90-106.
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    6. Valencia, Fabián, 2017. "Aggregate uncertainty and the supply of credit," Journal of Banking & Finance, Elsevier, vol. 81(C), pages 150-165.
    7. Hartman, Richard, 1972. "The effects of price and cost uncertainty on investment," Journal of Economic Theory, Elsevier, vol. 5(2), pages 258-266, October.
    8. Abel, Andrew B, 1983. "Optimal Investment under Uncertainty," American Economic Review, American Economic Association, vol. 73(1), pages 228-233, March.
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