Discussion paper

DP13205 Risk-Adjusted Capital Allocation and Misallocation

We develop a theory linking “misallocation,” i.e., dispersion in static marginal products
of capital (MPK), to systematic investment risks. In our setup, firms differ in their
exposure to these risks, which we show leads naturally to heterogeneity in firm-level risk
premia and, more importantly, MPK. The theory predicts that cross-sectional dispersion
in MPK (i) depends on cross-sectional dispersion in risk exposures and (ii) fluctuates with
the price of risk, and thus is countercyclical. We document strong empirical support for
these predictions. We devise a strategy to quantify variation in firm-level risk exposures
using data on the dispersion of expected stock market returns. Our estimates imply that
risk considerations explain almost 40% of observed MPK dispersion among US firms and
in particular, can rationalize a large persistent component in firm-level MPK deviations.
Our framework provides a sharp link between aggregate volatility, cross-sectional asset
pricing and long-run economic performance – MPK dispersion induced by risk premium
effects, although not prima facie inefficient, lowers the average level of aggregate TFP by
as much as 7%, suggesting large “productivity costs” of business cycles.


Schmid, L, J David and D Zeke (2018), ‘DP13205 Risk-Adjusted Capital Allocation and Misallocation‘, CEPR Discussion Paper No. 13205. CEPR Press, Paris & London. https://cepr.org/publications/dp13205