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Incomplete markets as correlated distortions

Armangué-Jubert, Tristany ; Pietrobon, Davide LU and Ruggieri, Alessandro (2025) In Working Papers
Abstract
We argue that capital misallocation arises endogenously due to incomplete
consumption insurance. We model risk-averse entrepreneurs with
heterogeneous productivity who face idiosyncratic output shocks and choose
how much capital to rent before uncertainty unfolds. We show that incomplete
markets operate as correlated distortions, leading to a reallocation of
capital from more to less productive firms relative to the complete markets
benchmark. Using Portuguese administrative data, we document that capital
misallocation is greater in locations and industries with higher output
shock volatility, consistent with our framework. Leveraging the structure
of the model, we show that completing insurance markets... (More)
We argue that capital misallocation arises endogenously due to incomplete
consumption insurance. We model risk-averse entrepreneurs with
heterogeneous productivity who face idiosyncratic output shocks and choose
how much capital to rent before uncertainty unfolds. We show that incomplete
markets operate as correlated distortions, leading to a reallocation of
capital from more to less productive firms relative to the complete markets
benchmark. Using Portuguese administrative data, we document that capital
misallocation is greater in locations and industries with higher output
shock volatility, consistent with our framework. Leveraging the structure
of the model, we show that completing insurance markets increases aggregate
productivity and income by 64% and 97%, respectively. (Less)
Please use this url to cite or link to this publication:
author
; and
organization
publishing date
type
Working paper/Preprint
publication status
published
subject
keywords
Insurance, volatility, misallocation, distortions, efficiency, E22, D61, L23, L26
in
Working Papers
issue
2025:2
pages
54 pages
language
English
LU publication?
yes
id
5e275314-cba4-47c9-9133-1857300607d7
date added to LUP
2025-02-25 13:58:20
date last changed
2025-04-04 15:02:05
@misc{5e275314-cba4-47c9-9133-1857300607d7,
  abstract     = {{We argue that capital misallocation arises endogenously due to incomplete<br/>consumption insurance. We model risk-averse entrepreneurs with<br/>heterogeneous productivity who face idiosyncratic output shocks and choose<br/>how much capital to rent before uncertainty unfolds. We show that incomplete<br/>markets operate as correlated distortions, leading to a reallocation of<br/>capital from more to less productive firms relative to the complete markets<br/>benchmark. Using Portuguese administrative data, we document that capital<br/>misallocation is greater in locations and industries with higher output<br/>shock volatility, consistent with our framework. Leveraging the structure<br/>of the model, we show that completing insurance markets increases aggregate<br/>productivity and income by 64% and 97%, respectively.}},
  author       = {{Armangué-Jubert, Tristany and Pietrobon, Davide and Ruggieri, Alessandro}},
  keywords     = {{Insurance; volatility; misallocation; distortions; efficiency; E22; D61; L23; L26}},
  language     = {{eng}},
  month        = {{02}},
  note         = {{Working Paper}},
  number       = {{2025:2}},
  series       = {{Working Papers}},
  title        = {{Incomplete markets as correlated distortions}},
  url          = {{https://lup.lub.lu.se/search/files/209183160/WP25_2.pdf}},
  year         = {{2025}},
}