Adverse selection, slow-moving capital, and misallocation

William Fuchs, Brett Green and Dimitris Papanikolaou

Journal of Financial Economics, 2016, vol. 120, issue 2, 286-308

Abstract: We embed adverse selection into a dynamic, general equilibrium model with heterogeneous capital and study its implications for aggregate dynamics. The friction leads to delays in firms’ divestment decisions and thus slow recoveries from shocks, even when these shocks do not affect the economy’s potential output. The impediments to reallocation increase with the dispersion in productivity and decrease with the interest rate, the frequency of sectoral shocks, and households’ consumption smoothing motives. When households are risk averse, delaying reallocation serves as a hedge against future shocks, which can lead to persistent misallocation. Our model also provides a micro-foundation for convex adjustment costs and a link between the nature of these costs and the underlying economic environment.

Keywords: Misallocation; Adverse selection; General equilibrium; Convex adjustment costs (search for similar items in EconPapers)
JEL-codes: D24 D82 E22 E30 E44 (search for similar items in EconPapers)
Date: 2016
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (19)

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Related works:
Working Paper: Adverse Selection, Slow Moving Capital and Misallocation (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:120:y:2016:i:2:p:286-308

DOI: 10.1016/j.jfineco.2016.01.001

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