I construct a model of an asset market subject to search frictions, in an environment where both investment and asset liquidity (the speed of asset sales) are determined endogenously. The model provides a natural framework to analyze the interaction between capital reallocation and liquidity in response to aggregate shocks. The existing literature on capital reallocation has emphasized the role of asymmetric information or credit constraints as a source of liquidity frictions. I complement this work by considering search frictions. As in the unemployment literature, this leads me to jointly consider the determinants of capital reallocation and utilization as arising from a common source.
I define an asset as a business idea or production plan upon which physical capital can be invested in. Figure 1 summarizes the flow of assets through the economy. Assets are either owned by agents who use assets productively, i.e. "matched", or owned by agents who do not use the asset productively, i.e. "unmatched". Matched assets become unmatched at some exogenous "separation" rate. Search frictions imply it takes time to re-match assets, where the arrival rate of matches is determined by the endogenous ratio of potential asset buyers and sellers. Both matched and unmatched assets (and their capital stock) can become obsolescent and exit the economy, but are replaced by an exogenous measure of new assets, which are matched and invested in upon entry to the economy. The total population of assets is fixed.
I assess the quantitative implications of the model (section 3) using moments reported by Eisfeldt and Rampini (2006). I consider the impact of two types of exogenous shocks: technology shocks to the productivity of matches, and shocks to the separation rate of matches. Both predict a positive correlation between reallocation and aggregate output, and a negative correlation between the dispersion in productivity of capital and output as documented by Eisfeldt and Rampini (2006).
The main findings are as follows. Capital reallocation is associated with low average match rates of existing capital. This implies that changes in these rates lead to gradual adjustments in aggregate capital utilization, and this acts as a source of propagation of shocks on changes to aggregate output. The importance of this propagation mechanism depends on the response of capital utilization (relative to the overall response of output) in the context of the model following the aggregate shocks. The model can generate over half the overall change in output as sourced from changes in capital utilization. In the case of separation shocks, almost all the change in output is sourced from changes in capital utilization.
Download
PDF Ebook Capital Reallocation and Liquidity with Search Frictions
