Debt Financing, Used Capital Market and Capital Reallocation
I study how much do financial frictions and endogenous capital partial irreversibility explain aggregate investment volatility. I propose a heterogeneous firms model with real and financial frictions. Firms adjust their capital stock by trading on the used capital market, thus the capital partial irreversibility is endogenized by the price in the market. This irreversibility creates two opposite forces affecting investment volatility: (1) capital investment is relatively cheaper in the recession, and thus attracts firms to invest in capital, dampening the fall of aggregate investment. (2) In the downturn, irreversibility of capital increases, makes investment become riskier, which exacerbate the fall of aggregate investment. In my model, collateral constraints amplify the first force and dampen the response of aggregate investment to match the moments in the data. A collateral constraint based on the resale value of the capital unevenly affect firms’ borrowing capacity by their upward-/downward-adjustment decision. Such decision determines a new price of investment goods, and thus endogenously alters the collateral constraint.
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