A Searched-Based Model of Capital Reallocation

The importance of used capital market for firm investment has been increasing significantly over time, with the purchase of used capital accounting for 25% to 40% of firms' total investment nowadays. Data show that: (i) the quantity of used capital reallocation across firms is procyclical; (ii) the prices of used capital are procyclical and more so than those of new capital; and (iii) the prices of used capital are more volatile than those of new capital. We argue that both search frictions in the capital market and credit frictions in the financial market play an important role in generating these empirical regularities. Specifically, we build a general equilibrium model with such frictions to show that interactions between search frictions and financial frictions are essential to explain these stylized facts. Moreover, our model also sheds light on other important business-cycle puzzles, such as (i) the procyclicality of the dispersion of firms' investment rate, and (ii) the counter-cyclicality of the dispersion of firm productivity.