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How to use demand systems to evaluate risky projects, with an application to automobile production

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  • Friberg, Richard
  • Huse, Cristian

Abstract

This article introduces a method to quantify the effect of a firm’s strategic choices on the risk profile of its profits at different horizons. We combine a demand system for differentiated products with counterfactual paths of risk factors. Prices, costs and quantities respond endogenously to the counterfactual state of the world. The draws on risk factors are generated using copulas, in a way that flexibly can be adapted to the risks faced in various industries. We illustrate the method by studying how the US operations of German carmakers BMW and Porsche are affected by the decision to relocate production, i.e. operational hedging. We find that for plausible costs of building a plant, production in the US is attractive for BMW, but not for Porsche.

Suggested Citation

  • Friberg, Richard & Huse, Cristian, 2012. "How to use demand systems to evaluate risky projects, with an application to automobile production," CEPR Discussion Papers 9266, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:9266
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    Cited by:

    1. Huse, Cristian & Koptyug, Nikita, 2016. "Bailing on the car that wasn’t bailed out: bounding consumer reactions to financial distress," MPRA Paper 72796, University Library of Munich, Germany.

    More about this item

    Keywords

    demand estimation; Exchange rate exposure; operational hedging; risk management;

    JEL classification:

    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
    • L16 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Industrial Organization and Macroeconomics; Macroeconomic Industrial Structure
    • L62 - Industrial Organization - - Industry Studies: Manufacturing - - - Automobiles; Other Transportation Equipment; Related Parts and Equipment

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