Risky business

Journal

of Economic

Dynamics

and Control

12 (1988) 135. North-Holland

RISKY BUSINESS The Allocation of Capital Roger CRAINE hiversiry

of California, Berkeley, CA 94720, USA

The paper presented examines the effect of risk on the firm’s demand for capital and the equilibrium allocation of capital. Capital is an asset the firm uses to transfer sales between periods and an asset society uses to transfer consumption between periods. In many models of the firm the marginal revenue product of capital is convex in the price of output and productivity shocks, so an increase in risk increases the firm’s demand for capital. This partial equilibrium result seems to imply that society devotes more resources to riskier businesses. The paper shows that in a general equilibrium an increase in risk gives the intuitive result that capital is reallocated toward less risky technologies.

0165-1889/88/$3.5001988,

Elsevier Science Publishers

B.V. (North-Holland)