Empirical policy functions as benchmarks for evaluation of dynamic capital structure models

Bazdresch, Santiago (2011): Empirical policy functions as benchmarks for evaluation of dynamic capital structure models.

Abstract

This paper presents a set of benchmark moments for evaluation or estimation of quantitative capital structure models. The moments are directly related to the models being studied: the main features of each models' empirical policy functions. The paper describe a general method for estimating these benchmarks and shows that they ‘capture’ a substantial part of the actual variation in firms actions in the data. Two versions of these benchmarks are presented: one dimensional ones and two dimensional ones. In both cases we express these as the total change in the control variable and the change relative to the change in the state variable. The empirical policy functions turn out to be smooth and mostly monotonous. Three key numbers that we suggest quantitative dynamic models have match closely are that within firms, for every 10% increase in debt relative to assets investment relative to assets declines 3.7%, debt issuance relative to market value decreases 1.1% and equity issuance relative to market value increases 0.5%.

• Item Type: MPRA Paper
• Language: English
• Keywords: dynamic models of capital structure, policy function, value function, model evaluation
• Subjects: G - Financial Economics > G3 - Corporate Finance and Governance > G31 - Capital Budgeting ; Fixed Investment and Inventory Studies ; Capacity; C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C52 - Model Evaluation, Validation, and Selection; C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods and Methodology: General > C14 - Semiparametric and Nonparametric Methods: General; C - Mathematical and Quantitative Methods > C6 - Mathematical Methods ; Programming Models ; Mathematical and Simulation Modeling > C61 - Optimization Techniques ; Programming Models ; Dynamic Analysis; G - Financial Economics > G3 - Corporate Finance and Governance > G32 - Financing Policy ; Financial Risk and Risk Management ; Capital and Ownership Structure ; Value of Firms ; Goodwill

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