Uninsurable investment risks
This paper studies a general equilibrium economy in which agents
have the ability to invest in a risky technology. The investment
risk cannot be fully insured with optimal contracts because shocks
are private information. We show that the presence of investment
risks lead to under-accumulation of capital relative to an economy
where idiosyncratic shocks can be fully insured. We also show that
the availability of state-contingent (optimal)
contracts---compared to simple debt contracts---brings the
aggregate stock of capital close to the complete markets level.
Institutional reforms that make possible the use of these
contracts have important welfare consequences.