On the Strategic Value of Risk Management
49 Pages Posted: 13 Apr 2013
Date Written: March 26, 2013
This article examines how fi rms facing volatile input prices and holding some degree of market power in their product market link their risk management with their production or pricing strategies. This issue is relevant in many industries ranging from manufacturing to energy retailing, where risk averse fi rms decide on their hedging strategies before their product market strategies. We fi nd that hedging modi es the pricing and production strategies of firms. This strategic effect is channelled through the risk-adjusted expected cost, i.e., the expected marginal cost under the measure induced by shareholdersrisk aversion. It has diametrically opposed impacts depending on the nature of product market competition: hedging toughens quantity competition while it softens price competition. Finally, committing to a hedging strategy is always a best response to non committing, and is a dominant strategy if fi rms compete à la Hotelling.
Keywords: Risk management, Imperfect Competition
JEL Classification: L13, G32
Suggested Citation: Suggested Citation