No. 2008/37
Monopoly Power Limits Hedging Alexander Muermann
and Stephen H. Shore
Center for Financial Studies House of Finance Goethe-Universität Grüneburgplatz 1 60323 Frankfurt am Main Deutschland
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* This note was written by Muermann and Shore inspired by an idea initially considered by Shore and Glen Taksler in the earlier paper.
“Why don’t oil producers perfectly risk-share?” We thank Glen Taksler for his insights. We received valuable comments from Christian Laux, Volker Nocke, Matt White, and seminar participants at the Financial Markets Group of the LSE, the University of Frankfurt, Wharton, and the NBER. Muermann and Shore gratefully acknowledge support from the Risk Management and Decision Processes Center at the Wharton School
1 Vienna University of Economics and Business Administration, Department of Finance and Accounting, and CFS Heiligenstaedter Str. 46- 48, A-1190 Wien, Austria, phone: +43 1 31336 4948, e-mail: Alexander.muermann@wu-wien.ac.at
2 Johns Hopkins University, Department of Economics, 458 Mergenthaler Hall, Baltimore, MD 21218, USA, phone: +1 410 516 5564, e- mail: shore@jhu.edu
CFS Working Paper No. 2008/37
Monopoly Power Limits Hedging*
Alexander Muermann
1and Stephen H. Shore
2May, 2008
Abstract:
When a spot market monopolist participates in a derivatives market, she has an incentive to deviate from the spot market monopoly optimum to make her derivatives market position more profitable. When contracts can only be written contingent on the spot price, a risk- averse monopolist chooses to participate in the derivatives market to hedge her risk, and she reduces expected profits by doing so. However, eliminating all risk is impossible. These results are independent of the shape of the demand function, the distribution of demand shocks, the nature of preferences or the set of derivatives contracts.
JEL Classification: D24, G32
Keywords: Spot Market Power, Derivates Market, Hedging.
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Two-State Diagram
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Profit with high demand
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