Working Paper
When Liquidity Matters: Firm Balance Sheets during Large Crises
Abstract: We study how aggregate shocks shape the joint dynamics of credit spreads, debt, and liquid asset holdings for nonfinancial firms, focusing on the Great Financial Crisis (GFC) and COVID-19. Both episodes saw sharp credit spread increases and investment declines, but debt and liquidity fell during the GFC and rose during COVID-19. Cross-sectionally, leverage drove spreads and investment in the GFC, while liquidity dominated during COVID-19. We build a macro-finance model of firm capital structure with a liquidity motive for working capital. Calibrated to data, it attributes the GFC to real and financial shocks, and COVID-19 to an additional liquidity shock.
https://doi.org/10.20955/wp.2025.019
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Bibliographic Information
Provider: Federal Reserve Bank of St. Louis
Part of Series: Working Papers
Publication Date: 2025-08-14
Number: 2025-019