TAILIEUCHUNG - Output contingent securities and ecient investment by firms

Fundamental Indexation has also been effective in back-tested results both in Europe and Asia. Return statistics from 1987 through 2005 suggest that fundamentally- weighted indexes have outperformed capitalization-weighted indexes in Greece, Ireland, France, Switzerland, Germany and Denmark by over 200 basis points per annum. In Japan the out performance has been greater than 300 basis points a year. In emerging markets, the technique has shown even greater excess returns over capitalization- weighted indexes. Moreover, these higher returns have been achieved with lower volatility, thus producing higher Sharpe ratios . . | Output contingent securities and efficient investment by firms Luis . Braido EPGE FGV V. Filipe Martins-da-Rocha EPGE FGV March 1 2012 Abstract We study competitive economies in which firms make risky investments and markets allow decision makers to fully insure against aggregate outcome uncertainty but not necessarily against all primitive states of nature. It is well-known that the ability to contract upon a complete description of states of nature is unnecessary for achieving an efficient allocation of resources across consumers. The same is not immediate for the productive sector because the map between primitive states and aggregate output levels depends on endogenous investment decisions. We show that if each firm computes its value using competitive beliefs about how out-of-equilibrium input decisions affect the probability distribution of its output then competitive markets lead profitmaximizing firms and utility-maximizing consumers to achieve a Pareto optimal allocation of resources. We thank Michael Magill and Martine Quinzii for comments and encouragement. Financial support from CNPq is gratefully acknowledged. 1 Introduction Following the work by Leon Walras in the 19th century the general equilibrium literature focused on understanding how anonymous markets coordinate the production and consumption of goods in competitive economies. In this setting firms productive decisions and agents consumption choices are taken independently and market prices are the only instruments available to coordinate different wishes. Hayek 1945 supported the view that competitive prices have the capacity of aggregating the necessary social knowledge to induce efficient self-interested individual behaviors. This idea was rigorously formulated and independently proven by Kenneth J. Arrow Gerard Debreu and Lionel W. McKenzie during the 1950 s. They listed conditions for existence of a competitive equilibrium and proved that in absence of externalities and other market .

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