lec10_with_answers - Econ 138 Financial and Behavioral...

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Econ 138 Financial and Behavioral Economics Lecture 10: I/CF sensitivity and Diversi f cation Ulrike Malmendier UC Berkeley Tu, February 26, 2008
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Organization Using STATA in the computer lab in Barrow’s Hall (Room 64). (Out- side the lab, there is an announcement that students a letter from the department con f rming that the undergrad needs to use the lab.) Jenny Cornet sent the list of Econ 138 ID’s over to Jack Burris at SSIL, andhe l
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1 Investment-Cash Flow Sensitivity Empirical fact : Internal funds (retained earnings) are a dominant source of f nancing in all countries. Let’s introduce a variable name for pledgeable income: ρ p H ( R B p ) . Suppose our universe of f rms have all the same investment project with cost I and returns R or 0 (with probabilities p H or p L and 1 p H or 1 p L ) , but they are heterogeneous in pledgeable income p H ( R B p ) and available cash C .
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Further suppose pledgeable income and C are independently distributed. (Note that, given the identical investment projects across f rms, this amounts to B and C being independently distributed.) Realistic? Answer : No. Firms with more higher pledgeable income (lower private bene f ts) may have been able to invest more in the past and are richer today! C distributed G ( C ) , continuous cumulative distribution function with density g ( C ) . Which f rms receive f nancing? Answer :Tho sew i th p H ( R B p ) I
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What is the aggregate investment? (Remember that I , R , p H , p L are identical for all f rms.) Answer : The aggregate investment among all f rms with pledgeable in- come ρ is I ( ρ ) (1 G ( I ρ )) I . (Remember that the minimum required cash, C , for a given level of pledge- able income ρ is de f ned by C = I ρ .) We can also calculate the aggregate investment among the full universe of f rms. Denote the cumulative distribution of ρ as H ( ρ ) ,w i thacon - tinuous density h ( ρ ) . Then, the aggregate investment among all f rms is R I ( ρ ) dH (
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Now consider a small, uniform increase in cash, δC for all f rms. How does the aggregate investment change? Answer : First note that a uniform increase in cash, δC for all f rms leads to a shift of the distribution function G ( C ) to the right. The new distribution function, say, e G ( C ) ,isde f ned by e G ( C )= G ( C δC ) and the new aggregate investment for all f rms with pledgeable income ρ is e I ( ρ ) (1 e G ( I ρ )) I =(1 G ( I ρ δC )) I. To evaluate the impact of a small, uniform increase in cash, δC for all f rms, let’s f rst consider the impact on investment among all f rms with a
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given pledgeable income ρ, δ e I ( ρ ) δC ,us inga f rst-o
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This note was uploaded on 04/02/2008 for the course ECON 138 taught by Professor Malmendier during the Spring '08 term at University of California, Berkeley.

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lec10_with_answers - Econ 138 Financial and Behavioral...

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