The welfare cost of ignoring the beta

Christian Gollier ()
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Christian Gollier: TSE-R - Toulouse School of Economics - UT Capitole - Université Toulouse Capitole - Comue de Toulouse - Communauté d'universités et établissements de Toulouse - EHESS - École des hautes études en sciences sociales - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement

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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: capital budgeting; rare disasters; WACC fallacy; Arrow-Lind theorem; carbon pricing; asset pricing; investment theory; Discounting (search for similar items in EconPapers)
Date: 2026-02
Note: View the original document on HAL open archive server: https://hal.science/hal-05483623v1
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Published in Journal of Political Economy Microeconomics, 2026, 3 (4), ⟨10.1086/733779⟩

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-05483623

DOI: 10.1086/733779

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