The Link between Short-Termism and Risk: Barriers to Investment in Long-Term Projects
51 Pages Posted: 1 Apr 2020 Last revised: 25 Nov 2020
Date Written: March 7, 2020
We study how investments that require long-term financial commitments are affected by undiversifiable, uninsurable risk in the economic environment in the context of investor preferences characterized by decreasing absolute risk aversion and a desire for consumption smoothing. In our setting, if funds are committed long-term, they become unavailable in the short-term resulting in an increased exposure to shocks before maturity of the investment. Coupled with decreasing absolute risk aversion, this leads to an endogenous discounting of long-term projects. High perceived risk in the economic environment leads to low levels of long-term investment (short-termism). We also explore policy measures that can support long-term investment, 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
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