The origin of risk
From the QJE, by Alexandr Kopytov, Mathieu Taschereau-Dumouchel, and Zebang Xu: We propose a tractable model in which risk, at both the micro and macro levels, is endogenous and driven by incentives. In the model, each firm chooses the mean and the variance of its productivity process, as well as how it covaries with the productivity of other […] The post The origin of risk appeared first on…
Risk, both at the individual and aggregate levels, emerges from the incentives that drive behavior, according to a novel model proposed by Alexandr Kopytov, Mathieu Taschereau-Dumouchel, and Zebang Xu. Each firm in the model selects its own productivity mean, variance, and correlation with other firms' productivity. This interdependence leads to aggregate risk when firms choose processes that align with one another.
The theory predicts that larger firms and those with lower markups exhibit lower volatility and correlation with overall productivity. Empirical evidence supports these predictions. However, distortions like taxes and markups can exacerbate risk-taking decisions, making GDP more volatile at the macro level. Removing these distortions, as shown in a calibrated version of the model, significantly reduces GDP volatility.
The work draws upon Fischer Black's insights and contributes to the broader understanding of risk and business cycles, building on my earlier book on the subject.
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