Entry, Imperfect Competition, and Futures Market for the Input
HEC Montreal - Department of Finance
University of Virginia - Department of Economics
July 27, 2014
International Journal of Industrial Organization, 35(C):70-83, 2014.
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 face an entry 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 the 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), both production and output price depend on uncertainty and risk aversion. Specifically, when entry is endogenized and the futures price is not actuarially fair, 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 price. In general, the effect of access to the futures market on the number of firms and production is ambiguous.
The appendices for this paper are available at the following URL: http://ssrn.com/abstract=2450698
Number of Pages in PDF File: 50
Keywords: Cournot, Entry, Futures, Hedging, Imperfect Competition
JEL Classification: D21, D43, D80, G32, L13
Date posted: March 20, 2012 ; Last revised: October 30, 2014