Abstract
We develop a two sector general equilibrium model with capital accumulation and convex adjustment costs. We use the model to study capital asset pricing and reallocation, as well as optimal consumption and investment decisions. With two sectors, the consumer balances diversification against the potential productivity and efficiency gains of investing more heavily in one sector. The general framework nests and extends standard equilibrium macro-asset pricing models. We show conditions under which aggregates are immune to the distribution of capital and in contrast, when the distribution becomes crucial for both sectoral and aggregate values.
Applications of the framework highlight the importance of heterogeneity and capital liquidity — the ability to reallocate capital — for economic growth and asset pricing. Misallocated capital creates risk and reduces utility, but correcting it through capital reallocation reduces efficiency and growth.