Real Effects of the Subprime Mortgage Crisis: Is it a Demand Or a Finance Shock?
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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Alternative Measure of Financial Dependence
TED Eurodollar bond over Treasury Bond spread around September 11th
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2001 terrorist attack beta Book/Market ratio change in stock Column commodity price indexes commodity price movement constraint and demand consumer confidence consumer demand contraction contraction of consumer currency and commodity degree of liquidity demand for external demand shock dependence on external drop in stock ex ante exchange rates exposures to exchange External Finance Dependence fall in stock Federal Reserve financial constraint firm’s sensitivity George Soros HH portfolio interest rate International Monetary Fund intrinsic dependence July 31 key regressors log stock price loss of consumer measure of liquidity negative coefficient non-financial firms percent level percentage changes placebo test point estimates R-squared Rajan and Zingales rates and commodity real economy regressions robustness check RZ index sample period sector-level sensitivity to consumer sensitivity to demand September 11 statistically significant stock price change stock price declines subprime crisis period subprime mortgage Table tightening liquidity constraint Tobin's q U.S. dollar Whited and Wu Whited-Wu index