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The impact of inflation risk on forward trading and production

This note examines the behavior of a competitive firm that faces joint price and inflation risk. Given that the price risk is negatively correlated with the inflation risk in the sense of expectation dependence, the firm optimally opts for an over-hedge if the firm's coefficient of relative risk aversion is everywhere no greater than unity. Furthermore, banning the firm from forward trading may induce the firm to produce more or less, depending on whether the price risk premium is positive or negative, respectively. While the price risk premium is unambiguously negative in the absence of the inflation risk, it is not the case when the inflation risk prevails. In contrast to the conventional wisdom, forward hedging needs not always promote production should firms take in inflation seriously.

Identiferoai:union.ndltd.org:DRESDEN/oai:qucosa:de:qucosa:28241
Date11 September 2014
CreatorsBroll, Udo, Wong, Kit Pong
PublisherTechnische Universität Dresden
Source SetsHochschulschriftenserver (HSSS) der SLUB Dresden
LanguageEnglish
Detected LanguageEnglish
Typedoc-type:workingPaper, info:eu-repo/semantics/workingPaper, doc-type:Text
Rightsinfo:eu-repo/semantics/openAccess
Relationurn:nbn:de:bsz:14-qucosa-149658, qucosa:28214

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