A Comoment Criterion for the Choice of Risky Investment by Firms

22 Pages Posted: 10 Aug 2010

See all articles by Michael J. P. Magill

Michael J. P. Magill

University of Southern California - Department of Economics

Martine Quinzii

University of California, Davis - Department of Economics

Abstract

This article uses Taylor series expansions and the assumption of small risks to derive a comoment criterion that firms should maximize so that the resulting equilibrium is Pareto optimal. This is done in two models of production under uncertainty: the state-of-nature model in which the firms’ outputs depend on states of nature and financial markets are complete with respect to these states of nature and the probability model in which the firms’ risky outputs are modeled by their joint probabilities and financial markets span the outcome space of the firms. The comoment criterion provides a unifying framework for the two equilibrium models of production under uncertainty, has the merit of being based on information which is readily available to firms, and provides greater insight than the theoretical criterion into the risk characteristics of its profit stream that a firm should focus on when choosing its investment plan.

Suggested Citation

Magill, Michael J. P. and Quinzii, Martine, A Comoment Criterion for the Choice of Risky Investment by Firms. International Economic Review, Vol. 51, No. 3, pp. 723-744, August 2010. Available at SSRN: https://ssrn.com/abstract=1654636 or http://dx.doi.org/10.1111/j.1468-2354.2010.00599.x

Michael J. P. Magill (Contact Author)

University of Southern California - Department of Economics ( email )

3620 South Vermont Ave. Kaprielian (KAP) Hall, 300
Los Angeles, CA 90089
United States
213-740-2104 (Phone)
213-740-8543 (Fax)

Martine Quinzii

University of California, Davis - Department of Economics ( email )

One Shields Drive
Davis, CA 95616-8578
United States
530-752-1567 (Phone)
530-752-9382 (Fax)

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