Are news shocks, which change agents' expectations about future fundamentals, an important source of business-cycle fluctuations? The existing literature has provided a wide range of answers, finding that news shocks can account for 10 percent to 60 percent of the volatility of output. We show that looking at the dynamics of inventories, so far neglected in this literature, cleanly isolates the role of news shocks in driving business cycles. In particular, inventory dynamics provide an upper bound on the explanatory power of news shocks. We show, for a broad class of theoretical models, that finished-good inventories must fall when there is an increase in consumption and investment induced by news shocks. When good news about future fundamentals lowers expected future marginal costs, firms delay current production and satisfy the increase in demand by selling from existing inventories. This result is robust across the nature of the news and the presence of different types of adjustment costs. We therefore propose a novel empirical identification strategy for news shocks: negative comovement between inventories and components of private spending. Estimating a structural VAR with sign restrictions on inventories, consumption and investment, our identified shock explains at most 20 percent of output variations. Intuitively, since inventories are procyclical in the data, shocks that generate negative comovement between inventories and sales cannot account for the bulk of business-cycle fluctuations.

We develop a noisy rational expectations model of financial trade featuring investors who acquire information and trade at a range of different frequencies. In the model, a restriction on high-frequency trading affects efficiency of prices at high frequencies, but leaves low-frequency efficiency unaffected. In a particular equilibrium of the model, traders specialize into trading at individual frequencies. We show that high- and low-frequency investors coexist, trade with each other, and make money from each other. The model matches numerous basic features of financial markets: investors endogenously specialize into strategies distinguished by frequency; volume is disproportionately driven by high-frequency traders; and the portfolio holdings of informed investors forecast returns at the same frequencies as those at which they trade.

The composition of corporate borrowing between bank loans and market debt varies substantially, both across countries and over the business cycle. This paper develops a new model of firm dynamics, where firms choose both the scale and composition of their borrowing, in order to understand the aggregate implications of variation in debt structure. Banks are assumed to differ from markets in their ability to restructure debt payments when a firm is in financial distress; however, banks' flexibility in distress comes at the expense of tougher lending standards. The steady-state of the model is consistent with key cross-sectional facts about debt composition: in particular, firms simultaneously use bank loans and market debt, and the share of bank loans in total debt is negatively related to its net worth. Over the business cycle, I show that asymmetric shocks to banks' lending costs generate substitution from bank loans to market debt, as in the US during the 2007-2009 recession. Additionally, these shocks have magnified effects if the economy is initially more bank-reliant. For example, the recession they generate is 15 -30% deeper in a version of the model calibrated to Europe than in one calibrated to the US. I then study the macroeconomic effects of corporate finance policies aimed at encouraging market debt financing by small and medium-sized firms. While these policies stimulate investment of small firms, they also induce mid-sized firms to adopt a debt structure that increases their vulnerability to financial distress. “What do inventories tell us about news?"

This paper studies the optimal maturity structure of debt in a neo-classical investment model with financial frictions. External financing is costly because firms have limited liability, and default entails deadweight output losses. Firms operate long-dated assets, and may thus want to issue long-term debt in order to mitigate liquidity risk. However, lack of commitment on the firms’ part makes long-term debt issuance costly, relative to short-term debt. In theory, the optimal maturity structure of debt should trade off these two forces. In numerical calibrations of the model, however, lack of commitment often dominates. Optimal borrowing policies often involve maturity shortening, either by letting outstanding long-term debt roll off, or by foregoing investment and using resources to repurchase outstanding debt at discount prices. The results suggests that the agency costs associated with long-term debt issuance are large, and that maturity adjusmtent can substantially alter investment dynamics.

I propose a static model of the joint determination of debt structure and the scale of investment. An entrepreneur finances a project of variable size using internal funds and external borrowing from two types of creditors: banks and public debt markets. The key distinction between the two is that, when liquidation looms, bank loans are easier to restructure than market debt. Absent deadweight losses in liquidation, debt structure is irrelevant to the investment choices of the entrepreneur, and projects are financed by whichever lender has the lowest marginal lending cost. With liquidation losses, I show that investment is financed by a combination of bank and market finance so long as 1) banks have higher marginal lending costs than markets and 2) entrepreneurs' internal resources are sufficiently small. In that case, the share of bank finance in total investment depends non-monotonically on internal resources: firms with very limited internal resources are increasingly reliant on bank finance to expand investment, while medium-sized firms reduce the contribution of bank finance for each additional marginal unit of equity. I show that, as a result of firms adopting mixed debt structures, asymmetric changes in lending costs lead to large changes in investment at the firm level.

We provide new evidence on behavior of small and large firms over the business cycle. Drawing from confidential firm-level quarterly data from the US Census Bureau on the income statements and balance sheets of US manufacturing firms from 1977 to 2014, we show that sales, inventory growth, and investment rates are more cyclical among smaller firms. This excess sensitivity holds after controlling for industry effects, and is driven by the behavior of firms in the top 0.5% of the asset distribution. Nevertheless, we show that the excess sensitivity survives when directly controlling for firm leverage, liquidity, or bank dependency, suggesting that it may not be driven by differences in access to credit. Additionally, we find that independent of size, firms with zero debt exhibit less sensitivity to the business cycle than positive leverage firms. Finally, we show that, because of the extreme skewness of the distribution of sales and investment, the excess sensitivity is insufficient in magnitude to substantially affect the cyclical behavior of aggregates in our sample.