Adverse Selection, Slow Moving Capital and Misallocation

57 Pages Posted: 9 Oct 2013 Last revised: 9 Sep 2015

See all articles by William Fuchs

William Fuchs

University of Texas at Austin - Department of Finance; Universidad Carlos III de Madrid - Department of Economics

Brett S. Green

University of California, Berkeley - Haas School of Business; Washington University in St. Louis - John M. Olin Business School

Dimitris Papanikolaou

Northwestern University - Kellogg School of Management - Department of Finance; National Bureau of Economic Research (NBER)

Date Written: September 8, 2015

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

JEL Classification: D24, D82, E30, E22, E44

Suggested Citation

Fuchs, William Martin and Green, Brett S. and Papanikolaou, Dimitris, Adverse Selection, Slow Moving Capital and Misallocation (September 8, 2015). Journal of Financial Economics (JFE), Forthcoming. Available at SSRN: https://ssrn.com/abstract=2337329 or http://dx.doi.org/10.2139/ssrn.2337329

William Martin Fuchs

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States

Universidad Carlos III de Madrid - Department of Economics ( email )

Calle Madrid 126
Getafe, 28903
Spain

Brett S. Green (Contact Author)

University of California, Berkeley - Haas School of Business ( email )

2220 Piedmont Avenue
Berkeley, CA ca 94720
United States
5105759980 (Phone)

HOME PAGE: http://faculty.haas.berkeley.edu/bgreen/

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

Dimitris Papanikolaou

Northwestern University - Kellogg School of Management - Department of Finance ( email )

Evanston, IL 60208
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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