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Production and Anticipatory Hedging under Time‐Inconsistent Preferences

Donald Lien and Chia‐Feng (Jeffrey) Yu

Journal of Futures Markets, 2015, vol. 35, issue 10, 961-985

Abstract: This paper analyzes the production and hedging decisions of a competitive firm under price uncertainty and time‐inconsistent preferences. We show that the firm would over‐hedge and the output choice would be affected by the firm's preferences and the price distribution, thereby identifying a novel circumstance under which the full‐hedge theorem and the separation theorem may fail. Furthermore, when the firm can hedge at the same time as production or ahead of production, ex ante firm value is higher in the former case, suggesting that planning ahead for price risk may backfire in the presence of time‐inconsistent preferences. © 2014 Wiley Periodicals, Inc. Jrl Fut Mark 35:961–985, 2015

Date: 2015
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