The Market for Used Capital: Endogenous Irreversibility and Reallocation over the Business Cycle
This paper explains the procyclicality of capital reallocation documented by Eisfeldt and Rampini (2006) and Cui (2012) by endogenising the resale price of capital in a dynamic general equilibrium model with heterogeneous firms hit by aggregate and idiosyncratic productivity shocks. I build a simple theory of endogenous investment irreversibility by assuming that used investment goods are imperfect substitutes for newly produced ones because of firm-level capital specificity. This creates a downward sloping demand for used capital that shifts with aggregate shocks. In recessions, the wedge between the price of new investment goods and the resale price becomes larger, so that the option value of holding capital for unproductive firms rises and they optimally choose to sell less capital to productive firms, inducing an amplification mechanism on total output and measured Total Factor Productivity.
|Date of creation:||2013|
|Date of revision:|
|Contact details of provider:|| Postal: Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA|
Web page: http://www.EconomicDynamics.org/
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