Finance Papers

Document Type

Journal Article

Date of this Version

2006

Publication Source

Review of Financial Studies

Volume

19

Issue

4

Start Page

1321

Last Page

1356

DOI

10.1093/rfs/hhj040

Abstract

We use a production-based asset pricing model to investigate whether financing constraints are quantitatively important for the cross-section of returns. Specifically, we use GMM to explore the stochastic Euler equation imposed on returns by optimal investment. Our methods can identify the impact of financial frictions on the stochastic discount factor with cyclical variations in cost of external funds. We find that financing frictions provide a common factor that improves the pricing of cross-sectional returns. Moreover, the shadow cost of external funds exhibits strong procyclical variation, so that financial frictions are more important in relatively good economic conditions.

Copyright/Permission Statement

This is a pre-copyedited, author-produced PDF of an article accepted for publication in Review of Financial Studies following peer review. The version of record is available online at: http://dx.doi.org/10.1093/rfs/hhj040.

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Date Posted: 27 November 2017

This document has been peer reviewed.