Entry, Imperfect Competition, and Futures Market for the Input
HEC Montreal - Department of Finance
HEC Montreal, Institute of Applied Economics; Centre Interuniversitaire sur le Risque, les Politiques Economiques et l'Emploi (CIRPÉE)
October 21, 2013
We analyze firms’ entry, production and hedging decisions under imperfect competition. We consider an oligopoly industry producing a homogeneous output in which risk-averse firms incur a sunk cost upon entering the industry, and then compete in Cournot with one another. Each firm faces uncertainty in the input cost when making production decision, and has access to the futures market to hedge its random cost. We provide two sets of results. First, under general assumptions about risk preferences, demand, and uncertainty, we characterize the unique equilibrium. In contrast to previous results in the literature (without entry), production and output price depend on uncertainty and risk aversion. In other words, when entry is endogenized, access to the futures market does not lead to separation. Second, to study the effect of access to the futures market on entry and production, we restrict attention to constant absolute risk aversion (CARA) preferences, a linear demand, and a normal distribution for the spot input price. In general, the effect of access to the futures market on the number of firms and production is ambiguous. However, when the values of the model parameters lead to partial hedging, the effect is unambiguous. Under partial hedging, access to the futures market induces more firms to enter the market and each one of them to produce more.
Number of Pages in PDF File: 63
Keywords: Cournot, Entry, Futures, Hedging, Imperfect Competition
JEL Classification: D21, D43, D80, G32, L13working papers series
Date posted: March 20, 2012 ; Last revised: October 23, 2013
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