Working Paper

Risk-Adjusted Capital Allocation and Misallocation

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;

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Bibliographic Information

Provider: Federal Reserve Bank of Chicago

Part of Series: Working Paper Series

Publication Date: 2020-12-21

Number: WP-2020-34