The Link between Short-Termism and Risk: Barriers to Investment in Long-Term Projects
43 Pages Posted: 1 Apr 2020 Last revised: 27 Jul 2020
Date Written: March 7, 2020
We study the relative attractiveness of long-term projects in a stylized framework with decreasing absolute risk aversion, consumption smoothing and uninsurable, undiversifiable risk. We find that, in the presence of such risks, a decreasing absolute risk aversion can interact with the payoff structure of long-term projects creating an endogenous discounting of delayed payoffs. In contrast to traditional treatments of short-termism, the resulting discounting depends positively on risk, implying that risk exacerbates short-termist behavior. Our setting treats investment as a long-term commitment of resources that, once committed, become unavailable in the short term. We discuss what determines long-term investment in such a setting and also explore supportive policy measures that can be implemented, in particular, during times of increased uncertainty.
Keywords: short-termism, discounting, systematic risk, decreasing absolute risk-aversion, long-term projects, illiquid assets, optimal portfolio
JEL Classification: G11
Suggested Citation: Suggested Citation