How to Use Demand Systems to Evaluate Risky Projects, with an Application to Automobile Production

36 Pages Posted: 1 Feb 2013

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: December 2012

Abstract

This article introduces a method to quantify the effect of a firm’s strategic choices on the risk profile of its profits at different horizons. We combine a demand system for differentiated products with counterfactual paths of risk factors. Prices, costs and quantities respond endogenously to the counterfactual state of the world. The draws on risk factors are generated using copulas, in a way that flexibly can be adapted to the risks faced in various industries. We illustrate the method by studying how the US operations of German carmakers BMW and Porsche are affected by the decision to relocate production, i.e. operational hedging. We find that for plausible costs of building a plant, production in the US is attractive for BMW, but not for Porsche.

Keywords: demand estimation, Exchange rate exposure, operational hedging, risk management

JEL Classification: F23, L16, L62

Suggested Citation

Friberg, Richard and Huse, Cristian, How to Use Demand Systems to Evaluate Risky Projects, with an Application to Automobile Production (December 2012). CEPR Discussion Paper No. DP9266. Available at SSRN: https://ssrn.com/abstract=2210236

Richard Friberg (Contact Author)

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

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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