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Financial Intermediation and Capital Reallocation

Author

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  • Kai Li

    (HKUST)

  • Fang Yang

    (Louisiana State University)

  • Hengjie Ai

    (University of Minnesota)

Abstract

We develop a general equilibrium framework to quantify the importance of intermediated capital reallocation in affecting macroeconomic fluctuations and asset returns. In our model, financial intermediaries intermediate capital reallocation between low productivity firms with excess capital and high productivity firms who need credit. Because lending contracts cannot be perfectly enforced, capital misallocation lowers aggregate productivity when intermediaries are financially constrained. As a result, shocks originated from the financial sector manifest themselves as fluctuations in total factor productivity and account for most of the business cycle variations in macroeconomic quantities. Our model produces a pro-cyclical capital reallocation and is consistent with the stylized fact that the volatilities of productivity are counter-cyclical at both the firm and the aggregate level. On the asset pricing side, our model matches well moments of interest rate spreads in the data and successfully generates a high and counter-cyclical equity premium.

Suggested Citation

  • Kai Li & Fang Yang & Hengjie Ai, 2015. "Financial Intermediation and Capital Reallocation," 2015 Meeting Papers 429, Society for Economic Dynamics.
  • Handle: RePEc:red:sed015:429
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    Cited by:

    1. Vadim Elenev & Tim Landvoigt & Stijn Van Nieuwerburgh, 2021. "A Macroeconomic Model With Financially Constrained Producers and Intermediaries," Econometrica, Econometric Society, vol. 89(3), pages 1361-1418, May.
    2. Randall Wright & Sylvia Xiaolin Xiao & Yu Zhu, 2019. "Frictional Capital Reallocation I: Ex Ante Heterogeneity," Staff Working Papers 19-4, Bank of Canada.
    3. Randall Wright & Xiaolin Xiao & Yu Zhu, 2018. "Frictional Capital Reallocation II: Ex Post Heterogeneity," 2018 Meeting Papers 544, Society for Economic Dynamics.
    4. Sydney C. Ludvigson & Sai Ma & Serena Ng, 2015. "Uncertainty and Business Cycles: Exogenous Impulse or Endogenous Response?," NBER Working Papers 21803, National Bureau of Economic Research, Inc.

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    JEL classification:

    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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