Counterparty Risk: Implications for Network Linkages and Asset Prices. (22nd July 2022)

• Record Type: Journal Article
• Authors: Grigoris, Fotis; Hu, Yunzhi; Segal, Gill
• Editors: Koijen, Ralph
• Is Part Of: Review of financial studies. Volume 36:Number 2(2023)
• Page Start: 814
• Page End: 858
• Publication Date: 2022-07-22
• Subjects: G12 -- E32 -- E23 -- D25 -- L14; Finance -- United States -- Periodicals; Finance -- Periodicals; 332
• DOI: 10.1093/rfs/hhac044
• Languages: English
• ISSNs: 0893-9454

Abstract

Abstract: We study the relation between trade credit, asset prices, and production-network linkages. Empirically, firms extending more trade credit earn 7.6$\%$ p.a. lower risk premiums and maintain longer relationships with customers. Using a production-based model, we quantitatively explain these novel facts. Trade credit reduces the departure probability of high-quality customers, thereby reducing firms' exposures to systematic costs incurred in finding new customers. The mechanism predicts that the aggregate amount of trade credit proxies for customer-search costs and that suppliers with shorter-duration links to customers command higher expected returns. We confirm these and other novel predictions in the data.