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Endogenously Procyclical Liquidity, Capital Reallocation, and q

50 Pages Posted: 17 Nov 2014 Last revised: 12 Dec 2016

Melanie Cao

York University - Schulich School of Business

Shouyong Shi

Pennsylvania State University

Date Written: December 1, 2016

Abstract

Capital reallocation is procyclical and dispersion in Tobin's q across firms is acyclical or counter-cyclical. To explain these puzzling facts, we analyze the stochastic equilibrium with search frictions in the capital market and shocks to aggregate productivity. Market liquidity is determined endogenously. An economic boom induces more buyers to enter the capital market, which increases liquidity. As a result, the amount and the price of reallocated capital increase in a boom. Dispersion in q across firms is counter-cyclical if aggregate productivity is sufficiently persistent and procyclical otherwise. We extend the model to incorporate firm-specific productivity and document additional evidence.

Keywords: Endogenous liquidity, Capital reallocation, Tobin's q, Frictions

JEL Classification: E22, E44, G11.

Suggested Citation

Cao, Melanie and Shi, Shouyong, Endogenously Procyclical Liquidity, Capital Reallocation, and q (December 1, 2016). Available at SSRN: https://ssrn.com/abstract=2525544 or http://dx.doi.org/10.2139/ssrn.2525544

Melanie Cao

York University - Schulich School of Business ( email )

4700 Keele Street
Toronto, Ontario M3J 1P3
Canada
416-736-2100 ext. 33801 (Phone)

Shouyong Shi (Contact Author)

Pennsylvania State University ( email )

University Park
State College, PA 16802
United States

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