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Financial constraint risk (2006)
| Venue: | Review of Financial Studies |
| Citations: | 54 - 5 self |
BibTeX
@ARTICLE{Whited06financialconstraint,
author = {Toni M. Whited and Guojun Wu},
title = {Financial constraint risk},
journal = {Review of Financial Studies},
year = {2006},
pages = {531--559}
}
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Abstract
We construct an index of firms ’ external finance constraints via generalized method of moments (GMM) estimation of an investment Euler equation. Unlike the com-monly used KZ index, ours is consistent with firm characteristics associated with external finance constraints. Constrained firms ’ returns move together, suggesting the existence of a financial constraints factor. This factor earns a positive but insignif-icant average return. Much of the variation in this factor cannot be explained by the Fama–French and momentum factors. Cross-sectional regressions of returns on our index and other firm characteristics show that constrained firms earn higher returns and that the financial-constraints effect dominates the size effect. We explore the impact of firms ’ external finance constraints on their stock returns. Motivation for this inquiry starts with a large body of micro-econometric studies that have provided some evidence of an impact of external finance constraints on investment. For example, Whited (1992), Bond and Meghir (1994), and Love (2003) show that augmentations of an investment Euler equation that account for financial constraints improve
Keyphrases
financial constraint risk firm external finance constraint firm characteristic investment euler equation external finance constraint stock return generalized method momentum factor large body factor cannot financial constraint factor financial-constraints effect financial constraint kz index constrained firm insignif-icant average return micro-econometric study size effect constrained firm return cross-sectional regression fama french
