August 11, 2009

Variable Capital Utilization

The model outlined in Elbourne et al. (2009) is extended with a feature capturing a varying rate of capital utilization. The utilization rate can be chosen instantaneously by the capital owners. A higher utilization rate induces capital owners to receive a higher rental fee.

However, they incur a utilization cost which is increasing and convex in the utilization rate. A higher utilization rate makes capital users more productive at the expense of the higher rental fee.

The utilization feature results in less volatility in rental fees as well as less volatility in the real interest rate.