Risk spillovers and hedging: why do firms invest too much in systemic risk?
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.
|Date of creation:||May 2011|
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- Schmalensee, Richard., 1980.
"Economies of scale and barriers to entry,"
1130-80., Massachusetts Institute of Technology (MIT), Sloan School of Management.
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"The Role of Investment in Entry-Deterrence,"
Royal Economic Society, vol. 90(357), pages 95-106, March.
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- Eric S. Maskin, 1999. "Uncertainty and entry deterrence," Economic Theory, Springer, vol. 14(2), pages 429-437.
- Franco Modigliani, 1958. "New Developments on the Oligopoly Front," Journal of Political Economy, University of Chicago Press, vol. 66, pages 215.
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