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Prospect theory and two moment model: the firm under price uncertainty

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  • Broll, Udo
  • Egozcue, Martín
  • Wong, Wing-Keung

Abstract

Within the prospect theory the paper examines production and hedging decisions of a competitive firm under price uncertainty. We consider the prospect theory for the firm's utility function in the two moment model known as (mu,sigma)-preference. In contrast to the literature our findings show that the production under uncertainty can be larger than in the certainty case. Furthermore, we demonstrate that although the futures markets are unbiased the firm is overhedging. --

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Bibliographic Info

Paper provided by Dresden University of Technology, Faculty of Business and Economics, Department of Economics in its series Dresden Discussion Paper Series in Economics with number 01/09.

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Date of creation: 2009
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Handle: RePEc:zbw:tuddps:0109

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Postal: 01062 Dresden
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Web page: http://www.tu-dresden.de/wiwi/
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Related research

Keywords: Prospect theory; mean-variance model; price uncertainty;

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  1. Dominic Gasbarro & Wing-Keung Wong & J. Kenton Zumwalt, 2007. "Stochastic Dominance Analysis of iShares," Finance Working Papers 21919, East Asian Bureau of Economic Research.
  2. Broll, Udo & Wahl, Jack E. & Wong, Wing-Keung, 2006. "Elasticity of risk aversion and international trade," Economics Letters, Elsevier, vol. 92(1), pages 126-130, July.
  3. Thomas Eichner & Andreas Wagener, 2004. "Relative risk aversion, relative prudence and comparative statics under uncertainty: The case of (μ, σ)-preferences," Bulletin of Economic Research, Wiley Blackwell, vol. 56(2), pages 159-170, 04.
  4. Harald Battermann & Udo Broll & Jack Wahl, 2008. "Utility functions of equivalent form and the effect of parameter changes on optimum decision making," Economic Theory, Springer, vol. 34(3), pages 401-414, March.
  5. Wing-Keung Wong, 2007. "Stochastic Dominance and Mean-Variance Measures of Profit and Loss for Business Planning and Investment," SCAPE Policy Research Working Paper Series 0705, National University of Singapore, Department of Economics, SCAPE.
  6. Sandmo, Agnar, 1971. "On the Theory of the Competitive Firm under Price Uncertainty," American Economic Review, American Economic Association, vol. 61(1), pages 65-73, March.
  7. Ormiston, Michael B & Schlee, Edward E, 2001. "Mean-Variance Preferences and Investor Behaviour," Economic Journal, Royal Economic Society, vol. 111(474), pages 849-61, October.
  8. Feder, Gershon & Just, Richard E & Schmitz, Andrew, 1980. "Futures Markets and the Theory of the Firm under Price Uncertainty," The Quarterly Journal of Economics, MIT Press, vol. 94(2), pages 317-28, March.
  9. Wong, Wing-Keung & Li, Chi-Kwong, 1999. "A note on convex stochastic dominance," Economics Letters, Elsevier, vol. 62(3), pages 293-300, March.
  10. al-Nowaihi, Ali & Bradley, Ian & Dhami, Sanjit, 2008. "A note on the utility function under prospect theory," Economics Letters, Elsevier, vol. 99(2), pages 337-339, May.
  11. Holthausen, Duncan M, 1979. "Hedging and the Competitive Firm under Price Uncertainty," American Economic Review, American Economic Association, vol. 69(5), pages 989-95, December.
  12. Meyer, Jack, 1987. "Two-moment Decision Models and Expected Utility Maximization," American Economic Review, American Economic Association, vol. 77(3), pages 421-30, June.
  13. Kawai, Masahiro & Zilcha, Itzhak, 1986. "International trade with forward-futures markets under exchange rate and price uncertainty," Journal of International Economics, Elsevier, vol. 20(1-2), pages 83-98, February.
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