Regional investment under uncertain costs of location

Due to political and economic integration, firms face increasing opportunities for locating their activities in countries, regions and cities that provide the best business environment for their specific needs. In our study, we focus on the impact of economic risk and risk preferences upon regional allocation of capital investments. The source of risk stems from the difference in costs of location and the business cycle across regions. Firms are seeking ways to reduce their exposure of regional shocks. As a result, regional concentration of investment of capital is endogenous. A comparative static analysis shows that regional capital allocation depends upon the firm’s risk preferences. Our findings demonstrate the suitability of the two-moment approach with multiple risks as an alternative to the expected utility approach. The impact of changes in distribution parameters, such as the expected costs of location, the variance of costs of location and the correlation between locational costs (or the business cycle), can be fully characterized by the elasticity of risk aversion. Elements of risk preferences beyond risk aversion prove to be important to evaluate regional policies. This insight is of interest for empirical research in regional economics.