NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

New Activities, the Welfare Cost of Uncertainty and Investment Policies

Joshua Aizenman

NBER Working Paper No. 5825
Issued in November 1996
NBER Program(s):   ITI

This paper studies the effect of policy uncertainty on the formation of new activities in Romer's (1994) type of an economy, where productivity of labor increases with the number of capital goods. Adding a new capital good requires a capital specific set-up cost, invested prior to using the capital good. Agents are disappointment averse, putting greater utility weight on downside risk [as modeled by Gul (1991)]. Policy uncertainty is induced by the Disappointment aversion implies that investment, labor and capitalists' income drop at a rate proportional to the standard deviation of the tax rate. Hence, policy uncertainty induces first-order adverse effects, whereas policy uncertainty leads to second-order effects when consumers maximize the conventional expected utility. The adverse effects of policy uncertainty can be partially overcome by a proper investment policy. The paper interprets the tax concessions granted to multinationals as a commitment device that helps overcoming the adverse implications of policy uncertainty.

download in pdf format
   (1164 K)

email paper

This paper is available as PDF (1164 K) or via email.

Machine-readable bibliographic record - MARC, RIS, BibTeX

Published: International Journal of Finance & Economics, Vol. 3, no. 2 (April 1998): 97-110

 
Publications
Activities
Meetings
Data
People
About

Support
National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us