Scandinavian Working Papers in Economics
Working Papers,
Lund University, Department of Economics
No 2025:2: Incomplete Markets as Correlated Distortions
Tristany Armangue-Jubert (), Davide Pietrobon () and Alessandro Ruggieri ()
Additional contact information
Tristany Armangue-Jubert: Universitat Autònoma de Barcelona and Barcelona School of Economics, Postal: B3-126, Facultat d'Economia i Empresa Edifici B, UAB, 08193, Bellaterra, Spain
Davide Pietrobon: Department of Economics, Lund University, Postal: School of Economics and Management, Box 7080, S-220 07 Lund, Sweden
Alessandro Ruggieri: CUNEF Universidad, Postal: F4.1, C. de Leonardo Prieto Castro, 2, 28040, Madrid , Spain
Abstract: We argue that capital misallocation arises endogenously due to incomplete consumption insurance. We model risk-averse entrepreneurs with heterogeneous productivity who face idiosyncratic output shocks and choose how much capital to rent before uncertainty unfolds. We show that incomplete markets operate as correlated distortions, leading to a reallocation of capital from more to less productive firms relative to the complete markets benchmark. Using Portuguese administrative data, we document that capital misallocation is greater in locations and industries with higher output shock volatility, consistent with our framework. Leveraging the structure of the model, we show that completing insurance markets increases aggregate productivity and income by 64% and 97%, respectively.
Keywords: Insurance; volatility; misallocation; distortions; efficiency.
Language: English
55 pages, February 26, 2025
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