Risk spillovers and hedging: why do firms invest too much in systemic risk?
AbstractAbstract In this paper we show that free entry decisions may be socially inefficient, even in a perfectly competitive homogeneous goods market with non-lumpy investments. In our model, inefficient entry decisions are the result of risk-aversion of incumbent producers and consumers, combined with incomplete financial markets which limit risk-sharing between market actors. Investments in productive assets affect the distribution of equilibrium prices and quantities, and create risk spillovers. From a societal perspective, entrants underinvest in technologies that would reduce systemic sector risk, and may overinvest in risk-increasing technologies. The inefficiency is shown to disappear when a complete financial market of tradable risk-sharing instruments is available, although the introduction of any individual tradable instrument may actually decrease efficiency. We therefore believe that sectors without well-developed financial markets will benefit from sector-specific regulation of investment decisions.
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Bibliographic InfoPaper provided by Katholieke Universiteit Leuven in its series Open Access publications from Katholieke Universiteit Leuven with number urn:hdl:123456789/313247.
Date of creation: May 2011
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- Willems, Bert & Morbee, J., 2011. "Risk Spillovers and Hedging: Why Do Firms Invest Too Much in Systemic Risk?," Discussion Paper 2011-057, Tilburg University, Center for Economic Research.
- Bert WILLEMS & Joris MORBEE, 2011. "Risk spillovers and hedging: why do firms invest too much in systemic risk?," Center for Economic Studies - Discussion papers ces11.17, Katholieke Universiteit Leuven, Centrum voor Economische Studiën.
- Willems, Bert & Morbee, J., 2011. "Risk Spillovers and Hedging: Why Do Firms Invest Too Much in Systemic Risk?," Discussion Paper 2011-029, Tilburg University, Tilburg Law and Economic Center.
- L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation
- L97 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Utilities: General
- H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
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Open Access publications from Katholieke Universiteit Leuven
urn:hdl:123456789/198270, Katholieke Universiteit Leuven.
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