Abstract
How do firms adjust their balance sheets and reallocate capital stock in response to recurrent productivity or profitability shocks? Why does capital reallocation fluctuate procyclically, while the potential benefits to reallocate appear to be countercyclical? To answer these questions, this paper develops a tractable dynamic general equilibrium model. In the model, firms face idiosyncratic productivity shocks while at the same time are restricted by the illiquidity of capital stock and financing constraints. The model shows that asset illiquidity and financing constraints interact and generate capital reallocation delays. These delays result in cross-sectional productivity dispersion and losses of total factor productivity (TFP), which become more severe during recessions.
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