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RFS Advance Access published online on March 15, 2006
Review of Financial Studies, doi:10.1093/rfs/hhj040
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© The Author 2006. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org

Article

Asset Pricing Implications of Firms’ Financing Constraints

João F. Gomes 1 *, Amir Yaron 2, and Lu Zhang 3
1 University of Pennsylvania and CEPR
2 University of Pennsylvania and NBER
3 University of Rochester and NBER

* To whom correspondence should be addressed.
João F. Gomes, E-mail: gomesj{at}wharton.upenn.edu


  Abstract

We use a production-based asset pricing model to investigate whether financing constraints are quantitatively important for the cross-section of returns. Specifically, we use GMM to explore the stochastic Euler equation imposed on returns by optimal investment. Our methods can identify the impact of financial frictions on the stochastic discount factor with cyclical variations in cost of external funds. We find that financing frictions provide a common factor that improves the pricing of cross-sectional returns. Moreover, the shadow cost of external funds exhibits strong procyclical variation, so that financial frictions are more important in relatively good economic conditions.


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