Working Paper

A Search-Based Neoclassical Model of Capital Reallocation

Abstract: As a form of investment, the importance of capital reallocation between firms has been increasing over time, with the purchase of used capital accounting for 25% to 40% of firms total investment nowadays. Cross- firm reallocation of used capital also exhibits intriguing business-cycle properties, such as (i) the illiquidity of used capital is countercyclical (or the quantity of used capital reallocation across rms is procyclical), (ii) the prices of used capital are procyclical and more so than those of new capital goods, and (iii) the dispersion of firms' TFP or MPK (or the bene t of capital reallocation) is countercyclical. We build a search-based neoclassical model to qualitatively and quantitatively explain these stylized facts. We show that search frictions in the capital market are essential for our empirical success but not sufficient---fi nancial frictions and endogenous movements in the distribution of rm-level TFP (or MPK) and interactions between used-capital investment and new investment are also required to simultaneously explain these stylized facts, especially that prices of used capital are more volatile than that of new investment and the dispersion of firm TFP is countercyclical.

Keywords: Capital Reallocation; Capital Search; Fragmented Markets; Endogenous Dispersion of rmsTFP; Endogenous Total Factor Productivity; Business Cycles;

JEL Classification: E22; E32; E44; G11;

https://doi.org/10.20955/wp.2018.017

Bibliographic Information

Provider: Federal Reserve Bank of St. Louis

Part of Series: Working Papers

Publication Date: 2018-08-01

Number: 2018-17

Pages: 27 pages