ENDOGENOUS PROCYCLICAL LIQUIDITY, CAPITAL REALLOCATION, AND q

Melanie Cao and Shouyong Shi

International Economic Review, 2023, vol. 64, issue 1, 95-128

Abstract: Capital reallocation is procyclical and an economic boom has a cleansing effect by shifting the distribution of firms from low quality to high quality. We explain these facts by modeling search frictions for used capital in the business cycle. The article characterizes the stochastic equilibrium analytically to prove that the liquidity and the price of reallocated capital are procyclical endogenously. We calibrate the model and construct proxies in the data for the unemployment rate of capital and the time on the market. These two variables have a strong positive relationship in both the model and the data.

Date: 2023
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