Zakrajšek, Egon; Matematični kolokvij december 2007

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Investment and the cost of capital: New evidence from the corporate bond market

Egon Zakrajšek

Division of Monetary Affairs, Federal Reserve Board, Washington, ZDA

6. december 2007

We study the effect of variation in interest rates on investment spending, employing a large panel data set that links yields on outstanding corporate bonds to the issuer income and balance sheet statements. The bond price data — based on trades in the secondary market — enable us to construct a firm-specific measure of the user cost of capital based on the marginal cost of external finance as determined in the market for long-term corporate debt. Our results imply a robust and quantitatively important effect of the user cost of capital on the firm-level investment decisions. According to our estimates, a 1 percentage point increase in the user cost of capital implies a reduction in the investment rate of 50 to 75 basis points and, in the long run, a 1 percent reduction in the stock of capital.

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