https://macropaperwarehouse.com/authors/galina-vereshchagina/Galina VereshchaginaHugo -- gohugo.ioen-ushttps://macropaperwarehouse.com/papers/firm-idiosyncratic-risk-and-productivity-investment-macroeconomic-implications/https://macropaperwarehouse.com/papers/firm-idiosyncratic-risk-and-productivity-investment-macroeconomic-implications/<p>This paper quantifies how idiosyncratic firm-level risk affects aggregate output, TFP, and firm life-cycle growth in an environment where firm productivity evolves endogenously through risky investment. The paper embeds endogenous productivity investment into a Lucas span-of-control model with risk-averse firm owners and endogenous entry and exit, and studies the effects of mean-preserving increases in the variance of returns to productivity investment. A mean-preserving increase in the variance of firm productivity shocks that raises the firm exit rate by 10% (from 0.10 to 0.11) is estimated to cause a 0.73% decline in output, a 0.38% decline in measured TFP, and a 3.69% decline in firm productivity investment; these elasticities remain approximately constant in the empirically relevant range. The driving force is that risk-averse firm owners reduce their risky productivity investment as variance rises; if capital financing constraints are present—as is common in developing economies—these effects are amplified and the increase in uncertainty may also slow firm life-cycle growth. Previously circulated as &ldquo;Uncertainty, Firm Lifecycle Growth, and Aggregate Productivity.&rdquo;</p>