Capital Misallocation and Risk Sharing

26 Pages Posted: 11 Mar 2020

See all articles by Hengjie Ai

Hengjie Ai

University of Minnesota - Twin Cities - Carlson School of Management

Anmol Bhandari

University of Minnesota - Minneapolis - Department of Economics

Yuchen Chen

University of Minnesota - Twin Cities, Carlson School of Management

Chao Ying

Chinese University of Hong Kong

Date Written: August 19, 2019

Abstract

We develop an optimal contracting model in which limited enforcement of financial contracts generates dispersion in marginal products of capital across firms. We show that the optimal contract can be implemented using state-contingent transfers and a simple collateral constraint that limits the capital input of firms by a fraction of the financial wealth of the firm owner. Compared to models with exogenous collateral constraint and incomplete markets (for example Moll (2014)), we find that the degree of measured misallocation is increasing in the persistence of the idiosyncratic productivity shocks. Under the optimal contract, the possibility to transfer wealth from high productivity states to low productivity states allows firm owners to trade off efficient allocation of consumption against the efficient allocation of capital. We show that for reasonable values of risk aversion, insurance needs more than offset production efficiency concerns.

Suggested Citation

Ai, Hengjie and Bhandari, Anmol and Chen, Yuchen and Ying, Chao, Capital Misallocation and Risk Sharing (August 19, 2019). Available at SSRN: https://ssrn.com/abstract=3521553 or http://dx.doi.org/10.2139/ssrn.3521553

Hengjie Ai (Contact Author)

University of Minnesota - Twin Cities - Carlson School of Management ( email )

19th Avenue South
Minneapolis, MN 55455
United States

Anmol Bhandari

University of Minnesota - Minneapolis - Department of Economics ( email )

1925 Fourth Street South
Minneapolis, MN
United States

Yuchen Chen

University of Minnesota - Twin Cities, Carlson School of Management ( email )

420 Delaware St. SE
Minneapolis, MN 55455
United States

Chao Ying

Chinese University of Hong Kong ( email )

Cheng Yu Tung Building
12 Chak Cheung Street
Shatin, NT
Hong Kong

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