Financial Constraints, Competition and Hedging in Industry Equilibrium
63 Pages Posted: 25 May 2004
Date Written: May 2006
We analyze the hedging decisions of firms, which take into account both the costs and the benefits of risk, in an equilibrium context. The equilibrium setting allows us to examine how a firm's hedging choice depends on the hedging choices of its competitors. We show that in equilibrium some firms hedge, while others do not, even though all firms are ex ante identical. The model further shows how the fraction of firms that hedge depends on industry characteristics, such as on the number of firms in the industry, the elasticity of demand, the convexity of production costs, and the relative market shares of each firm. Consistent with prior empirical findings the model predicts that we should observe more heterogeneity in the decision to hedge in the most competitive industries.
Keywords: Financial constraints, hedging, speculating, equilibrium, competition
JEL Classification: G32, G39, D21, D43
Suggested Citation: Suggested Citation