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A COMOMENT CRITERION FOR THE CHOICE OF RISKY INVESTMENT BY FIRMS *
Author(s) -
Magill Michael,
Quinzii Martine
Publication year - 2010
Publication title -
international economic review
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 2.658
H-Index - 86
eISSN - 1468-2354
pISSN - 0020-6598
DOI - 10.1111/j.1468-2354.2010.00599.x
Subject(s) - economics , profit (economics) , production (economics) , microeconomics , outcome (game theory) , investment (military) , pareto principle , financial market , econometrics , finance , operations management , politics , political science , law
This article uses Taylor series expansions and the assumption of small risks to derive a comoment criterion that firms should maximize so that the resulting equilibrium is Pareto optimal. This is done in two models of production under uncertainty: the state‐of‐nature model in which the firms’ outputs depend on states of nature and financial markets are complete with respect to these states of nature and the probability model in which the firms’ risky outputs are modeled by their joint probabilities and financial markets span the outcome space of the firms. The comoment criterion provides a unifying framework for the two equilibrium models of production under uncertainty, has the merit of being based on information which is readily available to firms, and provides greater insight than the theoretical criterion into the risk characteristics of its profit stream that a firm should focus on when choosing its investment plan.