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I am indebted to Pablo Andres Neumeyer and Vincenzo Quadrini for their support and advice throughout the development of this paper. I am also very thankful for helpful comments from Alejandro Izquierdo, Enrique Mendoza, Robert Townsend, and the seminar participants at the Inter-American Development Bank, International Monetary Fund, Midwest Macroeconomics Meetings, and the University of Southern California. Thanks to Ning Fu for excellent research assistance.
Calvo et al. (2006) find, in a sample of Sudden Stop episodes, that the recovery time to the pre-crisis output level averages around 2 years.
It is equivalent to think about this fall in capital as being a fall in utilized capital, i.e., the fall being partly due to a fall in capacity utilization. However for the sake of simplicity the paper does not impose frictions on investment and it is assumed that firms operate at full capacity.
A growing empirical and theoretical literature underline the presence of trend shocks in emerging countries. See for example, Aguiar and Gopinath (2006) and Yue (2010) for the role of stochastic trends in matching debt, default, and interest related patterns in the data. On the empirical side, Cerra and Saxena (2008) finds that low-income and emerging market countries have a greater volatility in the permanent component of the shocks than high income countries.
In Thailand, for example, stock market indices had not recovered to their pre-crisis level even by end-2007, before the recent 2008 global financial crisis sent the stocks plunging again.
When not specified, the term “financial frictions” is henceforth loosely used to refer to the frictions on equity issuance. Borrowing constraints are also a form of financial frictions, but will often be referred to by their name instead to differentiate between the two kind of frictions.
If we assume instead that firms cannot issue equity, this would lead to a stronger amplification effect of growth shocks. The advantage of the current approach is that one can vary the parameter that determines the cost on equity issuance to compare the frictionless case with the fully constrained case.
The indices shown in Figure 2 do not show a sign of recovery to their pre-crisis level until recently, in 2008, particularly in Indonesia and Malaysia, as the MSCI index of the Thai market is still, as of end-2009, significantly below its end-1996 level.
The use of balanced panel is also common in the literature that studies firms’ performance in emerging markets during a crisis since data on bankruptcies is not always readily available, and firms could delist for a host of other reasons. Given that the purpose of our study is not a systematic empirical analysis into the determinants of firms’ performance during the crisis, a balanced panel is well suited for our analysis. We are also confident that the size and leverage effects are not tainted with a survivorship bias view their significance, the relatively small number of bankruptcies, and the other citations that we provide in support of such correlations
Note that the crisis started during the second half of 1997, hence, end-1997 values of firms’ market value will not reflect the pre-crisis levels
Comparability with earlier studies is not always possible as the measures of performance as well as that of size differ across studies.
Since the crisis started during 1997, this justifies the use of 1996 as the pre-crisis year. As for the trough, some recovery was seen in some sectors during 1999. This and the short-lived rebound in many stocks justify the use of 1998 as the trough.
Since we assume a continuum of firms, by the law of large numbers the sample will be stationary, i.e.,
See, e.g., Chen and Ritter (2000) for a discussion on issuance costs. There is a growing evidence in the finance literature that managers prefer to smooth dividends, as first shown by Litner (1956). There is a theoretical literature that rationalizes dividend smoothing, see, for example, Miller and Rock (1985), Allen, Bernardo and Welch (2000), and Guttman, Kadan and Kandel (2007).
We detrend using the lag of the productivity trend so that the variables at time t that are in firms’s information set a time t − 1 remain in this set. This choice does not affect the solution of the problem (see e.g. Aguiar and Gopinath (2007).
When the transition probability is increased from 0% to 1.5% the parameter φ is set to 6.2 to match the leverage ratio of 0.52
When a transition probability of 3.3% is used in our case, the qualitative results are unaffected, but quantitatively the model generates smaller amplifications of a given shock under the banchmark conservative parameterization.
This follows from the fact that
Since the model is solved in a non linear way through iterations over the grid, keeping the size difference to a minimum significantly shortens the computational time.
In each period in the model a fraction of small firms receive a new and better technology. This creates a positive relationship between growth opportunities and next period’s performance in a non-crisis environment.