 The welfare cost of ignoring the betaChristian Gollier No 24-1556, TSE Working Papers from Toulouse School of Economics (TSE) Abstract: Because of risk aversion, any sensible investment valuation system should value less projects that contribute more to the aggregate risk. In theory, this is done by adjusting discount rates to consumption betas. But in reality, most public institutions use a dis-count rate that is rather insensitive to the risk profile of their investment projects. The economic consequences of the implied misallocation of capital are severe. I calibrate a Lucas model in which the investment opportunity set contains a constellation of projects with different expected returns and risk profiles. The model matches the traditional finan-cial and macro moments, together with the observed heterogeneity of assets’ risk profiles. The welfare loss of using a single discount rate is equivalent to a permanent reduction in consumption that lies somewhere between 15% and 45% depending upon which single discount rate is used. Keywords: Discounting; investment theory; asset pricing; carbon pricing; Arrow-Lind theorem; WACC fallacy; rare disasters; capital budgeting (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:tse:wpaper:129648 Access Statistics for this paper More papers in TSE Working Papers from Toulouse School of Economics (TSE) Contact information at EDIRC. |
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