This study provides a dynamic characterization of the link between financial distress risk and the real economy. Using a large dataset of firm-level observations, new ex-ante measures of financial distress are developed at the sector level and used to examine growth trends in the US economy. More specifically, we develop a comprehensive set-up for predicting ex-ante financial distress risk, then examine the effects of ex-ante financial distress risk on GDP growth. Our results show that over the period of 1970-2012, ex-ante financial distress risk contracts GDP growth by up to 9 per cent. The results also reveal greater contractions in exports and investment. The results remain unchanged when internal and external instruments are used to address endogeneity issues.
- Financial distress