The Role of Relative Price Volatility in the Efficiency of Investment Allocation

33 Pages Posted: 25 Apr 2011

See all articles by Eduardo A. Cavallo

Eduardo A. Cavallo

Inter-American Development Bank (IDB) - Research Department

Arturo José Galindo

Inter-American Development Bank

Alejandro Izquierdo

Inter-American Development Bank (IDB) - Research Department

John Leon-Diaz

Inter-American Development Bank (IDB) - Research Department

Date Written: August 2010

Abstract

This paper estimates the impact of relative price volatility on sector-level investment allocation using a panel of 65 countries with data for 26 manufacturing industries over the period 1985-2003. Results indicate that volatility distorts efficient investment allocation in that investment is not necessarily devoted to relatively more productive sectors, especially in emerging market economies that are highly exposed and may lack the necessary institutions to deal with it successfully. This is evidence in support of theories suggesting that relative price volatility provides incentives for entrepreneurs to adopt more “malleable” but less productive production technologies, enabling them to accommodate more easily abrupt and frequent changes in relative prices, but at the cost of using less productive technologies.

Suggested Citation

Cavallo, Eduardo A. and Galindo, Arturo José and Izquierdo, Alejandro and Leon-Diaz, John, The Role of Relative Price Volatility in the Efficiency of Investment Allocation (August 2010). IDB Working Paper No. 70, Available at SSRN: https://ssrn.com/abstract=1818748 or http://dx.doi.org/10.2139/ssrn.1818748

Eduardo A. Cavallo (Contact Author)

Inter-American Development Bank (IDB) - Research Department ( email )

1300 New York Ave., NW
Washington, DC 20577
United States

Arturo José Galindo

Inter-American Development Bank ( email )

1300 New York Avenue NW
Washington, DC 20577
United States

Alejandro Izquierdo

Inter-American Development Bank (IDB) - Research Department ( email )

1300 New York Ave., NW
Washington, DC 20577
United States

John Leon-Diaz

Inter-American Development Bank (IDB) - Research Department ( email )

1300 New York Ave., NW
Washington, DC 20577
United States

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