Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/144882
Authors: 
Broll, Udo
Wong, Kit Pong
Year of Publication: 
2014
Series/Report no.: 
Dresden Discussion Paper in Economics 02/14
Abstract: 
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 overhedge 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.
Subjects: 
Forward markets
Expectation dependence
Inflation risk
Production
JEL: 
D21
D24
D81
Document Type: 
Working Paper

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