Risk spillovers and hedging: why do firms invest too much in systemic risk?

Bert Willems and Joris Morbee

Working Papers of Department of Economics, Leuven from KU Leuven, Faculty of Economics and Business (FEB), Department of Economics, Leuven

Abstract: 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: 2011-05
New Economics Papers: this item is included in nep-ban, nep-bec, nep-reg and nep-upt
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https://lirias.kuleuven.be/bitstream/123456789/313247/1/DPS1117.pdf

Related works:
Working Paper: Risk Spillovers and Hedging: Why Do Firms Invest Too Much in Systemic Risk? (2012)
Working Paper: Risk Spillovers and Hedging: Why Do Firms Invest Too Much in Systemic Risk? (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:ete:ceswps:ces11.17

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