Production Flexibility and Hedging

Georges Dionne () and Marc Santugini ()
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Marc Santugini: HEC Montreal, Institute of Applied Economic

No 14-3, Working Papers from HEC Montreal, Canada Research Chair in Risk Management

Abstract: A risk-averse firm faces uncertainty about the spot price of the output, but has access to a futures market. The technology requires both capital and labor to produce the output. Due to the presence of flexibility in production, the level of capital and the volume of futures contracts are chosen under uncertainty (i.e., prior to observing the realized spot price) whereas the level of labor is set under certainty (i.e., after observing the realized spot price). When there is flexibility in production, the optimal production decisions are different between a risk-neutral firm and a risk-averse firm, i.e., the separation result does not hold. Moreover, flexibility in production implies only partial hedging with an actuarially fair futures price, i.e., the full-hedging result does not hold.

Keywords: Hedging; Flexibility; Full-Hedging; Production; Separation (search for similar items in EconPapers)
JEL-codes: G01 (search for similar items in EconPapers)
Pages: 15 pages
Date: 2014-04-24
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Related works:
Journal Article: Production Flexibility and Hedging (2015)
Working Paper: Production Flexibility and Hedging (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:ris:crcrmw:2014_003

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