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ENDOGENOUS PROCYCLICAL LIQUIDITY, CAPITAL REALLOCATION, AND q

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  • Melanie Cao
  • Shouyong Shi

Abstract

Capital reallocation is procyclical and an economic boom has a cleansing effect by shifting the distribution of firms from low quality to high quality. We explain these facts by modeling search frictions for used capital in the business cycle. The article characterizes the stochastic equilibrium analytically to prove that the liquidity and the price of reallocated capital are procyclical endogenously. We calibrate the model and construct proxies in the data for the unemployment rate of capital and the time on the market. These two variables have a strong positive relationship in both the model and the data.

Suggested Citation

  • Melanie Cao & Shouyong Shi, 2023. "ENDOGENOUS PROCYCLICAL LIQUIDITY, CAPITAL REALLOCATION, AND q," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 64(1), pages 95-128, February.
    • Handle: RePEc:wly:iecrev:v:64:y:2023:i:1:p:95-128
    DOI: 10.1111/iere.12594
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    References listed on IDEAS

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    Cited by:

    1. Marco Bassetto & Wei Cui, 2020. "A Ramsey Theory of Financial Distortions," Working Papers 775, Federal Reserve Bank of Minneapolis.

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