Financial Hedging and Product Market Rivalry

Abstract

This paper studies the optimal hedging and production strategies of financially constrained firms in imperfectly competitive markets. A hedging policy that minimizes the volatility of earnings reduces a firm's financial constraints most effectively on average, but makes it impossible for the firm to gain a significant financial advantage over its competitors. Because a financial advantage allows a firm to appropriate future market share, firms do not always hedge their entire risk exposure even in the absence of transaction costs. Oligopolistic firms hedge the least when they face intense competition and firms' financial condition is similar. Firms also hedge different risks from their competitors. Differences in the location of production are found to be unimportant for equilibrium risk exposure. Market leaders adopt less aggressive product market strategies and their competitors more aggressive ones when the firms hedge their exposures only partially.

Keywords: Hedging, product market competition

JEL Classification: L1, F3, G3