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Dynamic Inefficiency in Decentralized Capital Markets

Listed author(s):
  • Kurmann, André

    ()

    (School of Economics)

  • Rabinovich, Stanislav

    ()

    (Department of Economics Amherst College)

We study the efficiency implications of bargaining in frictional capital markets in which firms match bilaterally with dealers in order to buy or sell capital. We show how two of the distinguishing characteristics of capital – ownership and the intertemporal nature of investment – give rise to a dynamic inefficiency. Firms that anticipate buying capital in the future overinvest because this increases their outside option of no trade in negotiations with dealers in the future, thereby lowering the bargained purchase price. Vice versa, firms that anticipate selling capital in the future strategically underinvest because this increases the bargained sale price. If the only motive for trade is capital depreciation, there is overinvestment in capital. With stochastic productivity, there is insufficient dispersion of capital across firms and investment is insufficiently responsive to shocks. A regressive tax on capital can restore the efficient capital allocation.

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Paper provided by LeBow College of Business, Drexel University in its series School of Economics Working Paper Series with number 2016-1.

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Length: 35 pages
Date of creation: 17 Feb 2016
Handle: RePEc:ris:drxlwp:2016_001
Contact details of provider: Web page: http://www.lebow.drexel.edu/

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