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

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%.