An Endogenous Attitude to Firms’ Risk Aversion: A Model

The paper examines the risk behavior of a competitive firm under price uncertainty. The model developed in the paper departs from Greenwald and Stiglitz (1993a), which singly implies risk-averse behavior. The incorporation of more general assumptions about a firm’s financing – access to the equity market, the possibility of a soft budget constraint – allows the identification of a broader range of determinants of a firm’s attitude toward risk and, hence, optimal output. The results indicate that price and technology are not the only important factors in a firm’s optimal output level, as is the case for the neoclassical firm. The model also demonstrates that a firm’s net worth position, managerial sensitivity to bankruptcy, access to capital market, budget constraint softness, and degree of uncertainty about future prices may play important roles toward optimal output considerations.