The Effect of Business and Financial Market Cycles on Credit Ratings: Evidence from the Last Two Decades

We analyze the effect of business and financial market cycles on credit ratings using a sample of firms from the Russell 3000 index that are rated by Standard and Poor's over the period 1986–2012. We also examine investor reaction to credit rating actions in different stages of business and financial market cycles. We document that credit rating agencies are influenced by business and financial market cycles; they assign lower credit ratings during downturns of business and financial market cycles and higher ratings during upturns. Our study is the first to find strong evidence of pro‐cyclicality in credit ratings using a long window. We also document stronger investor reaction to negative credit rating actions during downturns. Our results confirm theoretical predictions and inform regulators.     

Understanding Bank and Nonbank Credit Cycles: A Structural Exploration

We explore the structural drivers of bank and nonbank credit cycles using a medium-scale dynamic stochastic general equilibrium (DSGE) model with two types of financial intermediation. We posit economywide and sectoral disturbances in both macro and financial sectors. We estimate that sectoral shocks to the balance sheets of entrepreneurs are important for fluctuations in bank and nonbank credit growth at the business cycle frequency. Economywide entrepreneurial risk shocks gain predominance for explaining the lower frequency comovement between the two series. Macro shocks play very little role in explaining financial cycles.     

Dynamic Residential Housing Cycles Analysis

This paper develops and tests a theoretical model for residential housing market cyclical dynamics. The model employs an interactive supply and demand framework to engender housing price dynamics. Under our set of assumptions, the two equation system is econometrically identified: the first equation, housing demand, relates rent, property values, and capitalization rates with demand fundamentals. The second equation, housing supply, relates housing investment and property values with supply fundamentals. Using the model, we analyze empirically the cyclical dynamics for residential properties in Los Angeles, San Francisco, San Diego and Sacramento for the 1988–2003 time period. The theoretical and econometric design represents improvements and/or modifications of previous studies in at least four ways. First, many of the earlier commercial cyclical analyses have focused on office appraisal and have relied on sparse transactions data, which are likely to be less reliable than the copious amount of residential transactions data. Second, the cyclical volatility and timing of single-family housing is different than that of commercial real estate. Third, by examining different local MSA markets in California, our study distinguishes and isolates national-macro, regional and local market variable effects upon cycles. Finally, utilizing quarterly data (versus annual data) sharpens our ability to focus upon cyclical behaviour. Our empirical analyses suggest that fundamentals, such as employment growth and interest rates are key determinants of the residential real estate cycles. However, in general, local fundamentals tend to have greater cyclical impacts than those of national or regional fundamentals.

Investment‐Specific News Shocks and U.S. Business Cycles

We provide robust evidence that news shocks about future investment‐specific technology (IST) constitute a significant force behind U.S. business cycles. Positive IST news shocks induce comovement, that is, raise output, consumption, investment, and hours. These shocks account for 70% of the business cycle variation in output, hours, and consumption, and 60% of the variation in investment, and have played an important role in 9 of the last 10 U.S. recessions. Our findings provide strong support for shifting focus to IST news shocks when investigating the role of news in driving U.S. business cycles.     

Macroeconomic News, Business Cycles and Australian Financial Markets

This paper examines the effects of news surprises of macroeconomic announcements on Australian financial markets across different business cycles. We find that overall, the news arrivals are influential in both stock and debt markets but in an interesting array of responses across asset classes. Debt markets are more responsive to macroeconomic news surprises compared to the stock market, hence supporting the notion that information revealed from the macroeconomic news is related to interest rates. Specifically, news about CPI is important over the full sample period and especially during expansions for both stock and bond returns while the unemployment rate news is influential to the money market rates. Furthermore, these effects are seemingly asymmetric in nature, with their directions and magnitudes conditional on the state of economy.     

Do financial variables help predict the state of the business cycle in small open economies? Evidence from Switzerland

We analyze the forecasting ability of financial variables to predict the state of the Swiss business cycle up to eight quarters ahead. Overall, our results suggest that financial variables convey leading information for the prediction of business cycles, even when applied to a small open economy. However, we clearly find that model specifications need to be extended to include variables accounting for external shocks, such as exchange rates or international commodity prices. It also appears that the forecasting contribution of individual variables changes over time. Specifically, in the last two decades, stock market liquidity has replaced the term spread as the best single predictor.     

Business cycles,financial cycles and capital structure

We perform peridogram based cycle analysis of firm capital structure and find evidence that firms’ leverage is both persistent and cyclical. The cyclicality of leverage is supported by the trade-off, pecking order and market timing capital structure theories (Korajczyk and Levy in J Financ Econ 68:75–109, 2003; Bhamra et al. in Rev Financ Stud 23:645–703, 2010). Although market timing theory research supports persistence, previous literature dictates that the trade-off and pecking order theories may predict either persistent or mean reverting leverage. Our tests reject mean reversion in favor of persistent and cyclical leverage. We corroborate pecking order theory literature that predicts leverage is persistent. In these models, when firms’ investment spending is below earnings, leverage decreases. In addition, we examine whether firms change their capital structure as a result of business and financial cycles. Since financial cycles last longer than business cycles, financial cycles should have a long term effect on leverage. Our findings confirm the persistent leverage business cycle models that suggest firms change their capital structure due to financial and credit cycles (Jermann and Quadrini in Am Econ Rev 102:238–271, 2012; Azariadis et al. in Rev Econ Stud 83:1364–1405, 2016). We conclude that leverage is persistent due to the cyclicality of the financing decision.     

Durable goods,financial frictions,and business cycles in emerging economies

Business cycles in emerging economies display very volatile consumption and strongly countercyclical trade balance. We show that aggregate consumption in these economies is not more volatile than output once durables are accounted for. Then, we present and estimate a real business cycles model for a small open economy that accounts for this empirical observation. Our results show that the role of permanent shocks to aggregate productivity in explaining cyclical fluctuations in emerging economies is considerably lower than previously documented. Moreover, we find that financial frictions are crucial to explain some key business cycle properties of these economies.     

Financial distress, bankruptcy law and the business cycle

This paper explores the business cycle implications of financial distress and bankruptcy law. We find that due to the presence of financial imperfections the effect of liquidations on the price of capital goods can generate endogenous fluctuations. We show that a law reform that ‘softens’ bankruptcy law may increase the amplitude of the cycle in the long run. In contrast, a policy of bailing out businesses during the bust or actively managing the interest rate across the cycle could stabilize the economy in the long run. A comprehensive welfare analysis of these policies is provided as well.      

The impact of working capital management on firm profitability in different business cycles: Evidence from Finland

The recent economic downturn of 2007–2008 has brought renewed focus on working capital policies. In this paper we examine the role of business cycles on the working capital–profitability relationship using a sample of Finnish listed companies over an 18-year period. We find the impact of business cycle on the working capital–profitability relationship is more pronounced in economic downturns relative to economic booms. We further show that the significance of efficient inventory management and accounts receivables conversion periods increase during periods of economic downturns. Our results demonstrate that active working capital management matters and, thus, should be included in firms’ financial planning.     

Credit cycle coherence in the eurozone: Was there a euro effect?

This paper examines effects of the euro introduction on credit cycle coherence in the eurozone through six channels. We construct and describe credit cycles for total bank credit, household mortgages and non-financial business loans for 16 EMU economies over 1990–2015. Credit cycle coherence is measured by synchronicity of cycle movements and similarity of their amplitudes. We find that the effect of euro introduction runs through elimination of currency risk and higher capital flows, which decrease coherence of total credit and mortgage credit cycles, but increase coherence of business credit cycles. Falling interest rates contribute to the convergence of total and mortgage credit cycles. Financial deregulation and legal harmonization are associated with lower coherence of all credit cycles, while trade openness has the opposite impact. The findings impinge on monetary policy effectiveness in the eurozone, with implications for macroprudential policy.     

How Do Capital Structure Policies of Emerging Markets Differ from Those of Developed Economies? Survey Evidence from Korea

We examine the capital structure policies of Korean firms using survey data for business group (chaebol) firms and independent firms. Our results are compared with findings in earlier studies for developed economies: Graham and Harvey (2001) for the United States and Brounen et al. (2004, 2006) for Europe. Korean chief financial officers are concerned about financial flexibility and volatility of earnings when issuing debt; they are concerned about target debt ratio maintenance and recent stock price increases when issuing equity. In contrast to independent firms, chaebol firms are more concerned about differences in corporate tax rates between foreign and domestic markets and the risk of refinancing in bad times. Chaebol firms are less likely to issue debt when faced with insufficient internal funds, which indicates that active internal capital markets are at work among the firms in a business group. Our results suggest that, compared to U. S. and European firms, Korean firms are under more pressure from their peers in formulating capital structure policies, consider equity a cheap source of financing, are less concerned with the dilution of earnings per share, and less frequently provide shares to employees as compensation.     

Business cycles in emerging economies: the role of interest rates

We find that in a sample of emerging economies business cycles are more volatile than in developed ones, real interest rates are countercyclical and lead the cycle, consumption is more volatile than output and net exports are strongly countercyclical. We present a model of a small open economy, where the real interest rate is decomposed in an international rate and a country risk component. Country risk is affected by fundamental shocks but, through the presence of working capital, also amplifies the effects of those shocks. The model generates business cycles consistent with Argentine data. Eliminating country risk lowers Argentine output volatility by 27% while stabilizing international rates lowers it by less than 3%.     

中美两国经济周期同步性研究

改革开放三十年以来,中芙两国经贸往来日益密切.从两国经济周期的同步程度来看,这三十年中,两国经济周期同步波动主要出现在2000年以后,我国进出口、投资等指标与美国消费之间的高度相关以及美国进出口与我国投资的高度相关是这种同步性得以实现的主要原因之一.中关两国经济周期的同步运动,主要源于美国经济周期对中国经济的影响.     

Markups and the Welfare Cost of Business Cycles: A Reappraisal

Gali, Gertler, and Lopez‐Salido (2007) recently show quantitatively that fluctuations in the efficiency of resource allocation do not generate sizable welfare costs. In their economy, which is distorted by monopolistic competition in the steady state, we show that they underestimate the welfare cost of these fluctuations by ignoring the negative effect of aggregate volatility on average consumption and leisure. As monopolistic suppliers, both firms and workers aim to preserve their expected markups; the interaction between aggregate fluctuations and price‐setting behavior results in average consumption and employment levels that are lower than their counterparts in the flexible‐price economy. This level effect increases the efficiency cost of business cycles. It is all the more sizable with the degree of inefficiency in the steady state, lower labor–supply elasticities, and when prices instead of wages are rigid.     

Are Chinese Stock Market Cycles Duration Independent?

This paper studies the duration properties of the Chinese stock market cycle. We find evidence for duration dependence in both A‐share and B‐share markets for whole cycles. The results reject the random‐walk hypotheses for both markets. For half cycles, evidence of duration dependence for expansions in the Shanghai A‐share market is found. For the Shenzhen B‐share market, there is little evidence of duration dependence for half cycles. Although the B‐share market is less liquid as compared to the A‐share market, the results of this study suggest that the B‐share market is more efficient than the A‐share market. An important implication is that the quality of market participants plays an important role in the duration property of the Chinese stock market.     

Business Cycle Synchronization of Turkey with the Eurozone and the United States: What Has Changed Since 2001?

Using wavelet methodology, we make a detailed spectral analysis of the business cycle synchronization of the Turkish economy with the eurozone and the United States. We take into account the dramatic change in the main economic indicators in the Turkish economy after the 2001 financial crisis. We find that the correlation of Turkish cycles with the cycles of the eurozone and the United States increased substantially after 2001. Moreover, the correlation of the Turkish cycles with the U.S. cycles is not lower than that with the euro cycles after 2001. Accordingly, analyzing the effect of international developments should not be confined to the trade channel. We submit that capital flows offer a reasonable explanation for the high correlation with the United States.     

Macroeconomic stability or financial stability: How are capital controls used? Insights from a new database

While the traditional objectives of capital controls were to address macroeconomic stability risks, a new “externalities view” has emerged prescribing their use to contain financial stability risks. In this context, our understanding of whether capital controls are used in practice to mitigate macroeconomic or financial stability remains limited. Using a novel database on high-frequency capital account regulations for 47 advanced and emerging economies from 2008 to 2020, this paper empirically assesses this question. Our main findings are that: (a) in emerging markets there is a strong association of capital controls on inflows to mitigate risks to macro stability but not financial stability risks; (b) in advanced economies there is a robust association between capital controls on inflows to lean against the buildup of financial stability but not macro stability risks; (c) banking sector flows, but not aggregate capital flows, are strongly associated with tightening capital controls on inflows in emerging markets; and (d) pooling advanced and emerging economies attenuates regression estimates and would lead to concluding that capital controls have weak association with both financial and macro stability motives. Our results can be rationalized by the greater capital flows, more volatile business cycles and stronger interaction between business and financial cycles in emerging markets, and the deeper asset markets found in advanced economies.     

Foreign Direct Investment and Debt Financing in Emerging Economies

The rich dynamics of capital flows is an important characteristic of business cycles in emerging market economies. In the data external debt is always procyclical, while FDI is procyclical only in normal times. We provide a microfounded rationale for this pattern by linking financial shocks to capital flows. For this purpose, we build a small open economy model in which firms are subject to borrowing constraints, and are either owned domestically or by foreign investors who purchase firms through FDI. During a financial crisis, the valuation gap per unit net worth between foreign and domestic investors widens, which triggers more FDI inflow. Our model produces business cycle moments consistent with empirical observations.     

Financial Development,Credit, and Business Cycles

How does financial development affect the magnitude of the business cycles fluctuations? We examine this question in a general equilibrium model with heterogeneous agents and endogenous credit constraints based on Kiyotaki (1998). We show that there is a hump‐shaped relationship between the degree of financial frictions and the amplification of unexpected productivity shocks. This nonmonotonic relation is due to the fall in financial frictions having two opposite effects on the response of output. One effect is the reallocation of productive inputs between agent types, which, while active, increases with the fall in financial frictions. The other effect is the change in the demand of inputs, which decreases with the fall in financial frictions. At low levels of financial development, the reallocation effect dominates and a fall in financial frictions increases the amplification of productivity shocks. In contrast, at higher levels of financial development, a fall in financial frictions decreases the shock amplification because the reallocation effect disappears while the effect on the demand of inputs is still present.