Financial Hedging and Product Market Rivalry

35 Pages Posted: 22 Mar 2005  

Antonio S. Mello

University of Wisconsin - Madison - Department of Finance, Investment and Banking

Martin E. Ruckes

Karlsruhe Institute of Technology

Date Written: March 15, 2005

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

Suggested Citation

Mello, Antonio S. and Ruckes, Martin E., Financial Hedging and Product Market Rivalry (March 15, 2005). Available at SSRN: https://ssrn.com/abstract=687140 or http://dx.doi.org/10.2139/ssrn.687140

Antonio S. Mello (Contact Author)

University of Wisconsin - Madison - Department of Finance, Investment and Banking ( email )

975 University Avenue
Madison, WI 53706
United States
608-263-3423 (Phone)
608-265-4195 (Fax)

Martin E. Ruckes

Karlsruhe Institute of Technology ( email )

Kaiserstraße 12
Karlsruhe, Baden Württemberg 76131
Germany

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