Capital Reallocation and Adverse Selection

65 Pages Posted: 17 Jul 2014 Last revised: 6 Mar 2015

Shaojin Li

Shanghai University of Finance and Economics - School of Finance

Toni M. Whited

University of Michigan, Stephen M. Ross School of Business; National Bureau of Economic Research

Date Written: March 3, 2015

Abstract

We investigate how adverse selection in the used capital market generates procyclical sales of used capital -- capital reallocation. In our model, adverse selection produces a resale discount for used capital. In equilibrium, this endogenous partial irreversibility is more severe in recessions than booms, leading to more reallocation in booms. The distribution of firm size affects the used capital price because aggregate shocks cause firms to exit and enter an investment inaction region, so higher moments of firm size affect the used capital price and investment. We find that neither frictionless models nor models with fixed irreversibility generate procyclical reallocation.

Keywords: Capital reallocation; adverse selection; general equilibrium

JEL Classification: E22; E23; E24; G31

Suggested Citation

Li, Shaojin and Whited, Toni M., Capital Reallocation and Adverse Selection (March 3, 2015). Simon Business School Working Paper No. FR 14-16. Available at SSRN: https://ssrn.com/abstract=2466602 or http://dx.doi.org/10.2139/ssrn.2466602

Shaojin Li

Shanghai University of Finance and Economics - School of Finance ( email )

200433
China
86-21-65908391 (Phone)

Toni M. Whited (Contact Author)

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

National Bureau of Economic Research ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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