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Dynamic Inefficiency in Decentralized Capital Markets

André Kurmann () and Stanislav Rabinovich ()

No 2016-1, School of Economics Working Paper Series from LeBow College of Business, Drexel University

Abstract: We study the efficiency implications of bargaining in frictional capital markets in which firms match bilaterally with dealers in order to buy or sell capital. We show how two of the distinguishing characteristics of capital – ownership and the intertemporal nature of investment – give rise to a dynamic inefficiency. Firms that anticipate buying capital in the future overinvest because this increases their outside option of no trade in negotiations with dealers in the future, thereby lowering the bargained purchase price. Vice versa, firms that anticipate selling capital in the future strategically underinvest because this increases the bargained sale price. If the only motive for trade is capital depreciation, there is overinvestment in capital. With stochastic productivity, there is insufficient dispersion of capital across firms and investment is insufficiently responsive to shocks. A regressive tax on capital can restore the efficient capital allocation.

Keywords: Dynamic inefficiency; trading frictions; bargaining; over-the-counter markets. (search for similar items in EconPapers)
JEL-codes: D83 G11 G12 (search for similar items in EconPapers)
Pages: 35 pages
Date: 2016-02-17
New Economics Papers: this item is included in nep-cfn and nep-dge
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Journal Article: Dynamic inefficiency in decentralized capital markets (2018) Downloads
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