Risk Aversion and Double Marginalization

Abstract

In vertical markets, eliminating double marginalization with a two-part tariff may not be possible due to downstream firms' risk aversion. When demand is uncertain, contracts with large fixed fees expose the downstream firm to more risk than contracts that are more reliant on variable fees. In equilibrium, contracts may thus rely on variable fees, giving rise to double marginalization. Counterintuitively, we show that increased demand risk or risk aversion can actually mitigate double marginalization. We also characterize several sufficient conditions under which increased risk or risk aversion does exacerbate double marginalization. We conclude with an application to merger analysis.* We thank Larry Samuelson for detailed and insightful comments.