Hedging to market‐wide shocks and competitive selection

Abstract

This paper examines hedging against a large market‐wide shock in a model with heterogeneous firms and sunk costs of entry. If hedging is voluntary only the most efficient firms hedge against this shock, a finding in line with empirical evidence but at odds with standard motivations for risk management. Hedging affects the critical level of the marginal cost needed to operate in the market. A setting with mandatory hedging is associated with stronger competition than when hedging is voluntary which, in turn, is associated with stronger competition than when hedging is unavailable.

The effectiveness of crude oil futures hedging during infectious disease outbreaks in the 21st century

“…Chang and Chang (2003) and Hatemi-J and Roca (2014) show that a sudden shift in market volatility reduces the optimal hedge ratio, and increases the cost of hedging. Firms that are well-prepared and capable of identifying a regime transition in a timely manner may be better able to withstand significant shocks to costs and/or demand, whereas weaker firms may be forced to exit the market (Friberg & Kupersmidt, 2023).…”