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Working Paper, No. 2020-34, December 2020 Crossref
Risk-Adjusted Capital Allocation and Misallocation

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.


Working papers are not edited, and all opinions and errors are the responsibility of the author(s). The views expressed do not necessarily reflect the views of the Federal Reserve Bank of Chicago or the Federal Reserve System.

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