Abstract
This paper examines the cyclicality of the finance premium in two financial frictions frameworks: the
‘cost channel’ and the ‘credit channel’ (BGG,1999). In the ‘cost channel’, we decompose the finance
premium into a ‘cost effect’ and a ‘leverage effect.’ In the ‘credit channel’ the finance premium is
driven by the ‘leverage effect’. We show that it is the size and direction of the ‘leverage effect’ that
determines the cyclicality of the finance premium in both frameworks. Key factors determining the
leverage effect are: the nature of shocks, the degree of loan persistence and the stance of monetary
policy.
‘cost channel’ and the ‘credit channel’ (BGG,1999). In the ‘cost channel’, we decompose the finance
premium into a ‘cost effect’ and a ‘leverage effect.’ In the ‘credit channel’ the finance premium is
driven by the ‘leverage effect’. We show that it is the size and direction of the ‘leverage effect’ that
determines the cyclicality of the finance premium in both frameworks. Key factors determining the
leverage effect are: the nature of shocks, the degree of loan persistence and the stance of monetary
policy.
| Original language | English |
|---|---|
| Publication status | Published - 2023 |