Economic theory has formalized the notion that monetary trade may benefit society. In the presence of frictions, money can expand allocations by facilitating spot trade. A key element is difficulties in carrying out intertemporal trades, originating from society’s incapacity to enforce contracts, agents’ inability to commit to future actions, and unobservability of trading histories (Kocherlakota, 1998).
Recent work has relaxed some of these assumptions to study how the availability of credit affects allocations and the role of money. Despite the different approaches adopted, a common feature exists: default is either ignored or inconsistent with equilibrium.
On Monday October 19, 1987, the U.S. equity market suffered its largest single-day percentage decline in history. The S&P 500 index fell by 57.86 points, a decline of 20.46%. The Dow Jones Industrial average suffered a similar decline, falling by 508 points, 22.6% of its value.
The NASDAQ fell by 46 points, 11.35% of its value (although many of the dealers stopped trading early, limiting the reported decline). An important, but often forgetten, factor in this decline was the 10.12% decline in the S&P 500 in the three trading days prior to October 19.
Firms do not operate in isolation. They are in constant strategic interaction with other firms, struggling for customers and market shares. While some firms have the luxury of operating in less competitive product markets, others face severe competition. This intense competition fundamentally affects the firms’ operating decisions and cash flows. While recent evidence supports the view that the intensity of competition has important implications for firms’ cash flows and stock returns (Gaspar and Massa, 2006; Hou and Robinson, 2006; Irvine and Pontiff, 2009; Hoberg and Phillips, 2010; Peress, 2010), the effect of competition on the pricing of debt has so far remained unclear.
