Risk Aversion and Double Marginalization

Soheil Ghili and Matt Schmitt

Journal of Industrial Economics, 2024, vol. 72, issue 2, 762-806

Abstract: In vertical markets, eliminating double marginalization with a two‐part tariff may not be possible due to risk aversion. Under uncertain demand, contracts with large fixed fees expose the downstream firm to more risk than contracts that are more reliant on variable fees. In equilibrium, contracts may thus rely on variable fees, giving rise to double marginalization. Counterintuitively, however, we show that increased demand risk or risk aversion can actually mitigate double marginalization. We also characterize several sufficient conditions under which increased risk or risk aversion is guaranteed to exacerbate double marginalization. We conclude by discussing potential applications and extensions.

Date: 2024
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