ABSTRACT

We study equity issues when the capacity of the market to absorb risk is limited and time-varying. The model can replicate the dynamics of prices and equity issues observed at the aggregate level. Firms issue equity at high prices and active issuance is followed by low returns. In the cross-section, the model predicts that firms with more arbitrage risk are less likely to issue equity. We find empirically that firms with stocks that are harder to arbitrage—illiquid stocks with bad substitutes—are less likely to issue equity, issue less equity as fraction of their assets, and have higher leverage.