Risk Spillovers and Hedging: Why Do Firms Invest Too Much in Systemic Risk?

Bert Willems and Joris Morbee

No 2012/35, RSCAS Working Papers from European University Institute

Abstract: In this paper we show that free entry decisions may be socially ineffcient, 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 effciency.

Date: 2012-06-05
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http://cadmus.eui.eu/bitstream/handle/1814/22778/RSCAS_2012_35.pdf?sequence=1 (application/pdf)
http://hdl.handle.net/1814/22778

Related works:
Working Paper: Risk spillovers and hedging: why do firms invest too much in systemic risk? (2011)
Working Paper: Risk Spillovers and Hedging: Why Do Firms Invest Too Much in Systemic Risk? (2011)
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