Risk-Adjusted Capital Allocation and Misallocation

85 Pages Posted: 28 Dec 2020

See all articles by Joel Michael David

Joel Michael David

Federal Reserve Bank of Chicago

Lukas Schmid

University of Southern California - Marshall School of Business

David Zeke

University of Southern California - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: December 18, 2020

Abstract

We develop a theory linking “misallocation,” i.e., dispersion in marginal products of capital (MPK), to macroeconomic risk. Dispersion in MPK depends on (i) heterogeneity in firm-level risk premia and (ii) the price of risk, and thus is countercyclical. We document strong empirical support for these predictions. Stock market-based measures of risk premia imply that risk considerations explain about 30% of observed MPK dispersion among US firms and rationalize a large persistent component in firm-level MPK. Risk-based MPK dispersion, although not prima facie inefficient, lowers long-run aggregate productivity by as much as 6%, suggesting large “productivity costs” of business cycles.

Keywords: misallocation, productivity, costs of business cycles, risk premia

JEL Classification: D24, D25, E22, E32, G12, O47

Suggested Citation

David, Joel Michael and Schmid, Lukas and Zeke, David, Risk-Adjusted Capital Allocation and Misallocation (December 18, 2020). FRB of Chicago Working Paper No. 2020-34, Available at SSRN: https://ssrn.com/abstract=3753061 or http://dx.doi.org/10.2139/ssrn.3753061

Joel Michael David (Contact Author)

Federal Reserve Bank of Chicago

230 South LaSalle Street
Chicago, IL 60604
United States

Lukas Schmid

University of Southern California - Marshall School of Business ( email )

701 Exposition Blvd, HOH 431
Los Angeles, CA California 90089-1424
United States

David Zeke

University of Southern California - Department of Economics ( email )

3620 South Vermont Ave. Kaprielian (KAP) Hall, 300
Los Angeles, CA 90089
United States

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