Risk Spillovers and Hedging

Why Do Firms Invest Too Much in Systemic Risk?

Bert Willems, J. Morbee

Research output: Working paperDiscussion paperOther research output

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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.
Original languageEnglish
Place of PublicationTilburg
PublisherEconomics
Volume2011-057
Publication statusPublished - 2011

Publication series

NameCentER Discussion Paper
Volume2011-057

Fingerprint

Hedging
Financial markets
Spillover
Systemic risk
Risk sharing
Free entry
Incomplete financial markets
Investment decision
Increasing risk
Equilibrium price
Assets
Risk aversion
Inefficiency
Incumbents

Keywords

  • investments in productive assets
  • hedging
  • systemic risk
  • risk spillovers

Cite this

Willems, B., & Morbee, J. (2011). Risk Spillovers and Hedging: Why Do Firms Invest Too Much in Systemic Risk? (CentER Discussion Paper; Vol. 2011-057). Tilburg: Economics.
Willems, Bert ; Morbee, J. / Risk Spillovers and Hedging : Why Do Firms Invest Too Much in Systemic Risk?. Tilburg : Economics, 2011. (CentER Discussion Paper).
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Willems, B & Morbee, J 2011 'Risk Spillovers and Hedging: Why Do Firms Invest Too Much in Systemic Risk?' CentER Discussion Paper, vol. 2011-057, Economics, Tilburg.

Risk Spillovers and Hedging : Why Do Firms Invest Too Much in Systemic Risk? / Willems, Bert; Morbee, J.

Tilburg : Economics, 2011. (CentER Discussion Paper; Vol. 2011-057).

Research output: Working paperDiscussion paperOther research output

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Willems B, Morbee J. Risk Spillovers and Hedging: Why Do Firms Invest Too Much in Systemic Risk? Tilburg: Economics. 2011. (CentER Discussion Paper).