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Background Risk and the Theory of the Competitive Firm under Uncertainty

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  • Wong, Kit Pong

Abstract

This paper examines the optimal production decision of a firm under output price risk "a la" Sandmo when the firm also faces a dependent background risk. It is shown that standard risk aversion plus a non-negative association between the output price risk and the background risk are sufficient to ensure a reduction in the firm's optimal output upon introduction of the background risk. The paper investigates the impact of a deterministic transformation of the background risk on the firm's optimal production decision. It is shown that decreasing absolute risk aversion in Ross' sense is among the sufficient conditions that generate an unambiguous negative comparative static result. Copyright 1996 by Blackwell Publishing Ltd and the Board of Trustees of the Bulletin of Economic Research

Suggested Citation

  • Wong, Kit Pong, 1996. "Background Risk and the Theory of the Competitive Firm under Uncertainty," Bulletin of Economic Research, Wiley Blackwell, vol. 48(3), pages 241-251, July.
    • Handle: RePEc:bla:buecrs:v:48:y:1996:i:3:p:241-51
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    Citations

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    Cited by:

    1. Kit, Pong Wong, 1997. "On the determinants of bank interest margins under credit and interest rate risks," Journal of Banking & Finance, Elsevier, vol. 21(2), pages 251-271, February.
    2. Wong, Kit Pong, 2017. "Production and hedging under state-dependent preferences and background risk," International Review of Economics & Finance, Elsevier, vol. 51(C), pages 527-534.
    3. Udo Broll & Jack E. Wahl, 2004. "Optimal hedge ratio and elasticity of risk aversion," Economics Bulletin, AccessEcon, vol. 6(5), pages 1-7.
    4. Kit Wong, 2000. "Insurance and the behavior of competitive firms under revenue risks: a note," Journal of Economics, Springer, vol. 71(3), pages 305-314, October.
    5. Pausch, Thilo, 2013. "Risk Sensitivity of Banks, Interbank Markets and the Effects of Liquidity Regulation," VfS Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order 79702, Verein für Socialpolitik / German Economic Association.
    6. Thilo Pausch, 2003. "Bank's Assets and Liabilities Management with Multiple Sources of Risk," Discussion Paper Series 245, Universitaet Augsburg, Institute for Economics.
    7. Wong, Kit Pong, 2006. "The effects of abandonment options on operating leverage and forward hedging," International Review of Economics & Finance, Elsevier, vol. 15(1), pages 72-86.
    8. repec:ebl:ecbull:v:6:y:2004:i:5:p:1-7 is not listed on IDEAS
    9. Wong, Kit Pong, 2002. "Production decisions in the presence of options: A note," International Review of Economics & Finance, Elsevier, vol. 11(1), pages 17-25, April.
    10. Kit Wong, 2014. "Production and hedging in futures markets with multiple delivery specifications," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 37(2), pages 413-421, October.
    11. Broll, Udo & Wong, Kit-Pong, 1997. "Hedging of exchange rate risk and regression dependence," Discussion Papers, Series II 355, University of Konstanz, Collaborative Research Centre (SFB) 178 "Internationalization of the Economy".
    12. Kit Pong Wong, 2007. "Optimal Export And Hedging Decisions When Forward Markets Are Incomplete," Bulletin of Economic Research, Wiley Blackwell, vol. 59(1), pages 67-81, January.
    13. Broll, Udo & Wong, Kit Pong, 2003. "Capital structure and the firm under uncertainty," Dresden Discussion Paper Series in Economics 20/03, Technische Universität Dresden, Faculty of Business and Economics, Department of Economics.
    14. Udo Broll & Kit Wong, 2013. "The firm under uncertainty: real and financial decisions," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 36(2), pages 125-136, November.
    15. Kick, Thomas & Pausch, Thilo & Ruprecht, Benedikt, 2015. "The winner's curse: Evidence on the danger of aggressive credit growth in banking," Discussion Papers 32/2015, Deutsche Bundesbank.
    16. Wong, Kit Pong, 2014. "Regret theory and the competitive firm," Economic Modelling, Elsevier, vol. 36(C), pages 172-175.
    17. Kit Wong, 2014. "Hedging and the competitive firm under correlated price and background risk," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 37(2), pages 329-340, October.
    18. Wong, Kit Pong, 2012. "Production and futures hedging with state-dependent background risk," International Review of Economics & Finance, Elsevier, vol. 24(C), pages 177-184.
    19. Kit Pong Wong, 2015. "A Smooth Ambiguity Model Of The Competitive Firm," Bulletin of Economic Research, Wiley Blackwell, vol. 67(S1), pages 97-110, December.
    20. Kit Pong Wong, 2003. "Forward Markets and the Behaviour of the Competitive Firm with Production Flexibility," Bulletin of Economic Research, Wiley Blackwell, vol. 55(3), pages 303-310, July.

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