Working Paper: CEPR ID: DP13205
Authors: Lukas Schmid; Joel David; David Zeke
Abstract: We develop a theory linking “misallocation,” i.e., dispersion in static marginal productsof capital (MPK), to systematic investment risks. In our setup, firms differ in theirexposure to these risks, which we show leads naturally to heterogeneity in firm-level riskpremia and, more importantly, MPK. The theory predicts that cross-sectional dispersionin MPK (i) depends on cross-sectional dispersion in risk exposures and (ii) fluctuates withthe price of risk, and thus is countercyclical. We document strong empirical support forthese predictions. We devise a strategy to quantify variation in firm-level risk exposuresusing data on the dispersion of expected stock market returns. Our estimates imply thatrisk considerations explain almost 40% of observed MPK dispersion among US firms andin particular, can rationalize a large persistent component in firm-level MPK deviations.Our framework provides a sharp link between aggregate volatility, cross-sectional assetpricing and long-run economic performance – MPK dispersion induced by risk premiumeffects, although not prima facie inefficient, lowers the average level of aggregate TFP byas much as 7%, suggesting large “productivity costs” of business cycles.
Keywords: misallocation; costs of business cycles; cross-section of returns; time-varying risk premia
JEL Codes: D25; E32; G12; O47
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| misallocation (dispersion in static marginal products of capital) (D29) | systematic investment risks (G11) |
| exposure to systematic risks (G11) | heterogeneity in firm-level risk premia (D29) |
| heterogeneity in firm-level risk premia (D29) | cross-sectional dispersion in MPK (D39) |
| cross-sectional dispersion in risk exposures (C46) | cross-sectional dispersion in MPK (D39) |
| risk premium variations (G19) | MPK dispersion (D39) |
| MPK dispersion (D39) | aggregate total factor productivity (TFP) (E23) |