Entry, Imperfect Competition, and Futures Market for the Input

Posted by D. Daniel Sokol

Georges Dionne, HEC Montreal - Department of Finance and Marc Santugini, HEC Montreal, Institute of Applied Economics discuss Entry, Imperfect Competition, and Futures Market for the Input.

ABSTRACT: We analyze firms’ production and hedging decisions under imperfect competition with potential entry. Specifically, we consider an oligopoly industry producing a homogeneous output in which risk-averse firms incur a sunk cost upon entering the industry, and, then, compete in Cournot with one another. Each firm faces uncertainty in the input cost when making production decision, and has access to the futures market to hedge its random cost. We provide two sets of results. First, we show that there exists a unique equilibrium in which, in contrast to previous results in the literature, production and output price depend on the distribution of the spot price and risk aversion, i.e., there is no separation when the firms have access to the futures market. Second, we study the effect of access to the futures market on entry, production, and prices. The effect of access to the futures market on the number of firms is ambiguous depending on the value of the futures price and the parameters of the model. We also show that hedging induces the risk-averse firm to produce more, while speculating reduces production.