Output contingent securities and efficient investment by firms
We analyze competitive financial economies in which firms make risky investments. Unlike the classic Arrow--Debreu framing, firms and agents cannot contract upon the exogenous states of nature underlying production risks. The only available securities are equities and all possible derivatives written on the endogenous aggregate output. It is well-known that this financial structure is rich enough to promote efficient risk sharing across consumers. However, markets are incomplete from the production perspective, and the absence of market prices for each primitive state of nature raises issues on the objective of firms. By exploring an additional layer of rationality on firms' and agents' expectations, we show that asset prices convey sufficient information to compute a competitive shareholder value that leads to efficient investment by firms.
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- Grossman, Sanford J & Hart, Oliver D, 1979. "A Theory of Competitive Equilibrium in Stock Market Economies," Econometrica, Econometric Society, vol. 47(2), pages 293-329, March.
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