The pure advantage of risk in production

Abstract

Increases in the riskiness of the productivity of a technology bring a benefit along with the cost of raising the variability of consumption. If the productivity realization is large the technology will be used but if it is small the technology can be shelved in favor of other technologies. This asymmetry implies that increases in risk raise total expected output and can be Pareto-improving (even for risk-averse agents) in contrast to the effect of riskier endowments. The observed expected output of risky technologies, however, will be less than that of safer technologies: empirical estimates of expected output are therefore a poor measure of efficiency. Risky production sets can be placed into a classical general equilibrium model in which firms will appropriate the gains to greater risk and choose the riskier technologies. The gains to risk can thus be delivered by markets and do not have to spread as an externality.