Incomplete markets as correlated distortions
We argue that capital misallocation arises endogenously due to incompleteconsumption insurance. We model risk-averse entrepreneurs withheterogeneous productivity who face idiosyncratic output shocks and choosehow much capital to rent before uncertainty unfolds. We show that incompletemarkets operate as correlated distortions, leading to a reallocation ofcapital from more to less productive firms r