50 Pages Posted: 17 Nov 2014 Last revised: 12 Dec 2016
Date Written: December 1, 2016
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: 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