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Risk Spillovers and Hedging: Why Do Firms Invest Too Much in Systemic Risk

CentER Discussion Paper No. 2011-057

TILEC Discussion Paper No. 2011-029

22 Pages Posted: 1 Jun 2011  

Bert Willems

Tilburg University - Department of Economics - CentER & TILEC

Joris Morbee

Catholic University of Leuven (KUL) - Center for Economic Studies and Energy Institute

Date Written: May 23, 2011

Abstract

In this paper we show that free entry decisions may be socially inefficient, even in a perfectly competitive homogeneous goods market with non-lumpy investments. In our model, inefficient entry decisions are the result of risk-aversion of incumbent producers and consumers, combined with incomplete financial markets which limit risk-sharing between market actors. Investments in productive assets affect the distribution of equilibrium prices and quantities, and create risk spillovers. From a societal perspective, entrants under-invest in technologies that would reduce systemic sector risk, and may over-invest in risk-increasing technologies. The inefficiency is shown to disappear when a complete financial market of tradable risk-sharing instruments is available, although the introduction of any individual tradable instrument may actually decrease efficiency. We therefore believe that sectors without well-developed financial markets will benefit from sector-specific regulation of investment decisions.

Keywords: investments in productive assets, hedging, systemic risk, risk spillovers

JEL Classification: L51, L97, H23, G11

Suggested Citation

Willems, Bert and Morbee, Joris, Risk Spillovers and Hedging: Why Do Firms Invest Too Much in Systemic Risk (May 23, 2011). CentER Discussion Paper No. 2011-057; TILEC Discussion Paper No. 2011-029. Available at SSRN: https://ssrn.com/abstract=1850543 or http://dx.doi.org/10.2139/ssrn.1850543

Bert Willems (Contact Author)

Tilburg University - Department of Economics - CentER & TILEC ( email )

P.O. Box 90153 Room K308
Tilburg, 5000LE
Netherlands
+31134662588 (Phone)

HOME PAGE: http://www.bertwillems.com

Joris Morbee

Catholic University of Leuven (KUL) - Center for Economic Studies and Energy Institute ( email )

Belgium

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