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On the strategic value of risk management


Léautier, Thomas-Olivier; Rochet, Jean-Charles (2013). On the strategic value of risk management. SFI Research Paper Series 13-20, Swiss Finance Institute.

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 with their production or pricing strategies. This issue is relevant in many industries ranging from manufacturing to energy retailing, where risk averse firms decide on their hedging strategies before their product market strategies. We find that 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 measure induced by shareholdersrisk aversion. It has diametrically opposed impacts depending on the nature of product market competition: hedging toughens quantity competition while it softens price competition. Finally, committing to a hedging strategy is always a best response to non committing, and is a dominant strategy if firms compete à la Hotelling.

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 with their production or pricing strategies. This issue is relevant in many industries ranging from manufacturing to energy retailing, where risk averse firms decide on their hedging strategies before their product market strategies. We find that 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 measure induced by shareholdersrisk aversion. It has diametrically opposed impacts depending on the nature of product market competition: hedging toughens quantity competition while it softens price competition. Finally, committing to a hedging strategy is always a best response to non committing, and is a dominant strategy if firms compete à la Hotelling.

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Additional indexing

Item Type:Working Paper
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
JEL Classification:L13, G32
Language:English
Date:26 March 2013
Deposited On:03 Mar 2014 09:55
Last Modified:15 Aug 2017 07:47
Series Name:SFI Research Paper Series
Number of Pages:44
Official URL:http://ssrn.com/abstract=2249840
Other Identification Number:merlin-id:9254

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