Discussion Paper

No. 2017-108 | December 08, 2017
Stock price related financial fragility and growth patterns


The total output of an economy usually follows cyclical movements which are accompanied by similar movements in stock prices. The common explanation relies
on the demand side. It points out that stock market wealth drives consumption which triggers production afterwards. This paper focuses on influences via the supply side of the economy. The aim of the paper is to explore channels where stock price patterns influence the amount of credit taken by firms. The author examines trend and volatility cycles on the stock market. There are three channels addressed: the stock market valuation as piece of information for the assessment of a firm’s creditworthiness, the influence on restructuring prospects in times of financial distress and the stock market related remuneration of the top management affecting capital demand. He asks to which extent a channel may contribute to the stock price-output relation when there is mutual feedback. A model à la Delli Gatti et al. (A new approach to business fluctuations: heterogeneous interacting agents, scaling laws and financial fragility, 2005) drives the results. Firms take credit to finance their production which determines their financial fragility. If their stochastic revenue is too low, they are bankrupt and leave the economy. The capital loss hurts the bank’s equity base and future credit supply is diminished. This causes business cycles. Results show that if the bank assesses creditworthiness according to the stock price then idiosyncratic stock price fluctuations have only a slight effect as they disturb selection and hinder growth. If stock market optimism matters for bankruptcy ruling the level of stock owners’ influence does not matter. If optimism is wide spread among stock investors however, investment behaviour is also correlated through the stock prices and this results in huge real economy cycles without any long-term growth. If volatility is considered in the decision of managers they act more prudently and this fosters growth.

JEL Classification:

E32, G30, C63


  • Downloads: 260


Cite As

Pascal Aßmuth (2017). Stock price related financial fragility and growth patterns. Economics Discussion Papers, No 2017-108, Kiel Institute for the World Economy. http://www.economics-ejournal.org/economics/discussionpapers/2017-108

Comments and Questions

Anonymous - Referee Report 1
December 22, 2017 - 14:00

I am no expert on the technicalities of agent-based models. Having said that, it seems to me that the model used in this paper is too complex, and at the same time too simple. It is too complex because it aims at exploring different channels through which the stock market ...[more]

... can influence the supply side of the economy, with special emphasis on the willingness of banks to provide credit, but given that the model is a very simplified representation of reality, the author fails to convince that results would be realistic.
The model is too simple on many respects: it ignores the labor market, and household behavior, and - which I believe is a serious limitation - it assumes that banks can only get funds from their own equities and deposits: no Central Bank refinancing. In addition, I understand that new firms emerge randomly with a given endowment, which implies that the increase in aggregate endowments in the economy is unexplained.
Getting rid of the Central Bank, interest rates must clear the market in the model, and this implies a degree of volatility which is completely unrealistic.
A minor point: the introduction of boom and busts in section 4.2 through the introduction of an exogenous cycle is very unsatisfactory.
Since extending the model obviously imply a complex and long period of additional research, I would suggest to rewrite the paper, starting from a simple description of a baseline solution, and presenting the different exercises as deviations from the baseline, so that the reader can be better convinced on the impact of each different channel of transmission, with respect to the baseline solution.

Pascal Aßmuth - Reply to Referee Report 1
March 19, 2018 - 16:16

See attached file