Date Added: Feb 2011
The author constructs a dynamic model of transactions in used capital to understand the role of leasing when trading is subject to frictions. Firms trade assets to adjust their productive capacity in response to shocks to profitability. Transaction costs hinder the efficiency of the allocation of capital, and lessors act as trading intermediaries who reduce trading frictions. The model predicts that leased assets trade more frequently and produce more output than owned assets, for two reasons. First, high-volatility firms are more likely to lease than low-volatility firms, since they expect to adjust their capacity more frequently. Second, ownership's larger transaction costs widen owners' inaction bands relative to lessees'.