Real Effects of the Subprime Mortgage Crisis

We develop a methodology to study how the subprime crisis spills over to the real economy. Does it manifest itself primarily through reducing consumer demand or through tightening liquidity constraint on non-financial firms? Since most non-financial firms have much larger cash holding than before, they appear unlikely to face significant liquidity constraint. We propose a methodology to estimate these two channels of spillovers. We first propose an index of a firm''s sensitivity to consumer demand, based on its response to the 9/11 shock in 2001. We then construct a separate firm-level index on financial constraint based on Whited and Wu (2006). We find that both channels are at work, but a tightened liquidity squeeze is economically more important than a reduced consumer spending in explaining cross firm differences in stock price declines.Consumer credit;Borrowing;External shocks;Liquidity controls;Spillovers;Stock prices;stock price, financial sector, stock returns, cash flow, equation, standard deviation, correlation, financial institutions, financial dependence, standard errors, bond, statistical significance, survey, statistics, financial system, stock price performance, treasury bond, stock of debt, correlations, stock price index, dollar bond, samples, stock index, fitted value, standard error, stock price reaction, stock price reactions, measurement error, stock value, cash flow from operations, financial intermediation, optimization, statistical analyses, pessimistic forecast, financial stock, hedging, empirical measure, hedging strategies, discount rate, cash flows, significance level, financial markets, international finance, currency futures, extrapolation, significance levels, financial market, financial sector crises, statistically significant effect, currency risk, expectation sign, forecasting, new york stock exchange