The Cost of Capital and Misallocation in the United States

Miguel Faria-e-Castro, Julian Kozlowski and Jeremy Majerovitz
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Jeremy Majerovitz: https://research.stlouisfed.org/econ/majerovitz/jp/

No 2025-013, Working Papers from Federal Reserve Bank of St. Louis

Abstract: We develop a methodology to estimate the cost of capital using credit registry microdata, and apply it to study capital allocation efficiency in the United States. Our measure incorporates the contractual interest rate, expected default probability, recovery rate, and expectations of future rates. We estimate three distinct rates: (i) the lender's discount rate, (ii) the firm's cost of capital, and (iii) the social cost of capital. We derive a sufficient statistic for misallocation based on the first and second moments of the social cost of capital. Dispersion in this rate captures both heterogeneity in lender discounting and the presence of financial frictions. Normal times feature modest amounts of misallocation, corresponding to an output loss of 0.5%. However, during the 2020-2021 period, misallocation increased to 1.1%, primarily due to the underpricing of riskier loans.

Keywords: cost of capital; misallocation; macrofinance (search for similar items in EconPapers)
JEL-codes: D24 E22 E44 O47 O51 (search for similar items in EconPapers)
Pages: 52 pages
Date: 2025-06-10
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DOI: 10.20955/wp.2025.013

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