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On the strategic value of risk management


L´eautier, Thomas-Olivier; Rochet, Jean-Charles (2014). On the strategic value of risk management. International Journal of Industrial Organization, 37:153-169.

Abstract

This article examines how firms facing volatile input prices and holding some degree of market power in their product market link their risk management and their production or pricing strategies. This issue is relevant in many industries ranging from manufacturing to energy retailing, where firms rendered "risk averse" by financial frictions decide on and commit to their hedging strategies before their product market strategies. We find that commitment to hedging modifies the pricing and production strategies of firms. This strategic effect is channelled through the risk-adjusted expected cost, i.e., the expected marginal cost under the probability measure induced by shareholders’ "risk aversion". It has opposite effects depending on the nature of product market competition: commitment to hedging toughens quantity competition while it softens price competition. Finally, not commiting to the hedging position can never be an equilibrium outcome: committing is always a best response to non committing. In the Hotelling model, committing is a dominant strategy for all firms.

Abstract

This article examines how firms facing volatile input prices and holding some degree of market power in their product market link their risk management and their production or pricing strategies. This issue is relevant in many industries ranging from manufacturing to energy retailing, where firms rendered "risk averse" by financial frictions decide on and commit to their hedging strategies before their product market strategies. We find that commitment to hedging modifies the pricing and production strategies of firms. This strategic effect is channelled through the risk-adjusted expected cost, i.e., the expected marginal cost under the probability measure induced by shareholders’ "risk aversion". It has opposite effects depending on the nature of product market competition: commitment to hedging toughens quantity competition while it softens price competition. Finally, not commiting to the hedging position can never be an equilibrium outcome: committing is always a best response to non committing. In the Hotelling model, committing is a dominant strategy for all firms.

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Additional indexing

Item Type:Journal Article, refereed, original work
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Language:English
Date:November 2014
Deposited On:20 Feb 2015 09:24
Last Modified:05 Apr 2016 18:58
Publisher:Elsevier
ISSN:0167-7187
Publisher DOI:https://doi.org/10.1016/j.ijindorg.2014.07.006
Official URL:http://www.sciencedirect.com/science/article/pii/S0167718714000654
Other Identification Number:merlin-id:10079

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