Misallocation and Asset Prices
We develop an endogenous growth model with heterogeneous firms facing financial frictions, where capital misallocation emerges as a key endogenous state variable. Misallocation is endogenously driven by transitory aggregate liquidity shocks, as firms with different productivity levels respond differently to the same shock by optimally adjusting capacity utilization. Financial frictions and persistent idiosyncratic productivity make capital reallocation gradual, leading to slow-moving misallocation that drives time-series variation in low-frequency economic growth and serves as a source of systematic risk in asset markets. This mechanism operates through a feedback loop induced by the valuation channel: persistent misallocation elevates risk premia, which depresses the marginal q of intangible capital and reduces R&D incentives. The resulting decline in expected long-run growth and rise in macroeconomic volatility further amplifies risk premia under recursive preferences. We provide empirical evidence that capital misallocation captures low-frequency growth fluctuations and present supporting tests that confirm the model’s key predictions.
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