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The Role of Relative Price Volatility in the Efficiency of Investment Allocation

  • Eduardo Cavallo

    ()

  • Arturo Galindo
  • Alejandro Izquierdo

    ()

  • John Jairo Leon

This paper estimates the impact of relative price volatility on sector-level investment allocation using a panel of 65 countries with data for 26 manufacturing industries over the period 1985-2003. Results indicate that volatility distorts efficient investment allocation in that investment is not necessarily devoted to relatively more productive sectors, especially in emerging market economies that are highly exposed and may lack the necessary institutions to deal with it successfully. This is evidence in support of theories suggesting that relative price volatility provides incentives for entrepreneurs to adopt more “malleable” but less productive production technologies, enabling them to accommodate more easily abrupt and frequent changes in relative prices, but at the cost of using less productive technologies.

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File URL: http://www.iadb.org/research/pub_hits.cfm?pub_id=IDB-WP-208&pub_file_name=pubIDB-WP-208.pdf
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Paper provided by Inter-American Development Bank, Research Department in its series Research Department Publications with number 4682.

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Date of creation: Aug 2010
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Handle: RePEc:idb:wpaper:4682
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  1. Andrew B. Abel & Janice C. Eberly, . "A Unified Model of Investment Under Uncertainty," Rodney L. White Center for Financial Research Working Papers 14-93, Wharton School Rodney L. White Center for Financial Research.
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  16. Tornell, Aaron, 1990. "Real vs. financial investment can Tobin taxes eliminate the irreversibility distortion?," Journal of Development Economics, Elsevier, vol. 32(2), pages 419-444, April.
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