Real Effects of the Subprime Mortgage Crisis: Is it a Demand or a Finance Shock?

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International Monetary Fund, Jul 1, 2008 - Business & Economics - 37 pages
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We develop a methodology to study how the subprime crisis spills over to the real economy. Does it manifest itself primarily through reducing consumer demand or through tightening liquidity constraint on non-financial firms? Since most non-financial firms have much larger cash holding than before, they appear unlikely to face significant liquidity constraint. We propose a methodology to estimate these two channels of spillovers. We first propose an index of a firm''s sensitivity to consumer demand, based on its response to the 9/11 shock in 2001. We then construct a separate firm-level index on financial constraint based on Whited and Wu (2006). We find that both channels are at work, but a tightened liquidity squeeze is economically more important than a reduced consumer spending in explaining cross firm differences in stock price declines.
 

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Contents

I Introduction
II Specification and Key Variables
ii
III Empirical Analysis
13
IV Conclusion
23
References
25
Tables
27
Figures
33
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