A COMOMENT CRITERION FOR THE CHOICE OF RISKY INVESTMENT BY FIRMS

Michael Magill and Martine Quinzii

International Economic Review, 2010, vol. 51, issue 3, 723-744

Abstract: This article uses Taylor series expansions and the assumption of small risks to derive a comoment criterion that firms should maximize so that the resulting equilibrium is Pareto optimal. This is done in two models of production under uncertainty: the state-of-nature model in which the firms' outputs depend on states of nature and financial markets are complete with respect to these states of nature and the probability model in which the firms' risky outputs are modeled by their joint probabilities and financial markets span the outcome space of the firms. The comoment criterion provides a unifying framework for the two equilibrium models of production under uncertainty, has the merit of being based on information which is readily available to firms, and provides greater insight than the theoretical criterion into the risk characteristics of its profit stream that a firm should focus on when choosing its investment plan. Copyright (2010) by the Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

Date: 2010
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