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The Output Decision of a Risk-Neutral Producer under Risk of Liquidation
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The Output Decision of a Risk-Neutral Producer under Risk of Liquidation
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The Output Decision of a Risk-Neutral Producer under Risk of Liquidation
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Journal Article
The Output Decision of a Risk-Neutral Producer under Risk of Liquidation
2000
Overview
A risk-neutral producer faces liquidity constraint that forces him to liquidate real assets in imperfect markets if he cannot meet his cash obligation, entailing a fixed liquidation cost. Under this risk of liquidation, the risk-neutral producer is shown to refuse to undertake a risky project with positive expected excess return, exhibiting first-order risk aversion. The optimal output level of the producer is piecewise linear in wealth; it decreases or increases depending on whether the expected excess return is positive or negative. The producer's apparent utility function exhibits an S-shaped curve when the initial liquid assets are affected by a background risk that is normally distributed.
