Risk Taking and Coordination Failures


Speaker:Adolfo de Motta, McGill
Date: Tuesday 12 February 2019
Time: 13:45
Location: Kolade Teaching Room

Further details

We study an economy where demand spillovers make firms' production decisions strategic complements. Firms have access to an increasing returns to scale technology and choose their operating leverage ex ante trading off higher fixed costs for lower variable costs. Operating leverage governs firm’s exposures to an aggregate labor productivity shock, the only source of uncertainty in the economy. In equilibrium, firms' operating leverage is too high because they do not internalize that an economy with higher aggregate leverage is more likely to fall into a self-fulfilling equilibrium with inefficiently low output after a bad productivity shock. Welfare losses coming from firms' failure to coordinate production ex post are amplified by suboptimal risk-taking ex ante. Excessive operating leverage contributes to systematic risk by magnifying the impact of productivity shocks onto aggregate output.