Using Demand Systems to Evaluate Risky Projects: An Application to the Automobile Industry

43 Pages Posted: 14 Mar 2011

See all articles by Richard Friberg

Richard Friberg

Stockholm School of Economics - Department of Economics

Cristian Huse

Stockholm School of Economics; Swedish House of Finance

Date Written: February 20, 2011

Abstract

We examine how the risk-return profiles of carmakers BMW and Porsche depend on whether car models are produced in the US or Europe. Using data from the US car market we combine a demand system for differentiated products with counterfactual paths to macroeconomic variables. We let prices and quantities respond to counterfactual values of exchange rates and consumer confidence. This allows us to generate counterfactual profit distributions at different horizons for alternative domestic and foreign production configurations. For plausible costs of building a plant, production in the US is attractive for BMW, but not for Porsche.

Keywords: Exchange rate exposure, net present value, certainty equivalent valuation, macroeconomic exposure, operational hedging, natural hedging, demand for cars

JEL Classification: F23, G32, L16, L62

Suggested Citation

Friberg, Richard and Huse, Cristian, Using Demand Systems to Evaluate Risky Projects: An Application to the Automobile Industry (February 20, 2011). Available at SSRN: https://ssrn.com/abstract=1780995 or http://dx.doi.org/10.2139/ssrn.1780995

Richard Friberg

Stockholm School of Economics - Department of Economics ( email )

P.O. Box 6501
Sveavagen 65
S-113 83 Stockholm
Sweden
+46 8 736 9645 (Phone)
+46 8 720 7752 (Fax)

Cristian Huse (Contact Author)

Stockholm School of Economics ( email )

PO Box 6501
Stockholm, 11383
Sweden

Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

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