IDEAS home Printed from https://ideas.repec.org/p/tse/wpaper/129648.html
   My bibliography  Save this paper

The welfare cost of ignoring the beta

Author

Listed:
  • Gollier, Christian

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.

Suggested Citation

  • Gollier, Christian, 2024. "The welfare cost of ignoring the beta," TSE Working Papers 24-1556, Toulouse School of Economics (TSE).
    • Handle: RePEc:tse:wpaper:129648
    as

    Download full text from publisher

    File URL: https://www.tse-fr.eu/sites/default/files/TSE/documents/doc/wp/2024/wp_tse_1556.pdf
    File Function: Full Text
    Download Restriction: no
    ---><---

    More about this item

    Keywords

    Discounting; investment theory; asset pricing; carbon pricing; Arrow-Lind theorem; WACC fallacy; rare disasters; capital budgeting;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • H43 - Public Economics - - Publicly Provided Goods - - - Project Evaluation; Social Discount Rate
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:tse:wpaper:129648. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no bibliographic references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: the person in charge (email available below). General contact details of provider: https://edirc.repec.org/data/tsetofr.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.