Investment Portfolio under Soft Budget: Implications for Growth, Volatility and Savings

Abstract

Consider an economy with a high risk and high return and a low risk and low return asset and risk-averse agents making intertemporal consumption and 'investment decisions. The agent will choose a savings rate to balance cur-rent and future consumption, and an investment portfolio to balance between return and risk. A Government program to insure the high risk and high return asset will lead to increased investment in the asset which in turn leads to higher total return, total risk and total savings in the economy, even if ex ante the program constitutes zero expected subsidy. The agent is worse off under such a program. These results reflect on the experiences of a number of Asian economies featured by interventionist government, hi savings, high growth and recent financial crisis.