No. 2008/37
Monopoly Power Limits Hedging
Alexander Muermann
and Stephen H. Shore
Center for Financial Studies
Goethe-Universität Frankfurt „ House of Finance
Grüneburgplatz 1 „ 60323 Frankfurt „ Deutschland
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Fax: +49 (0)69 798-30077
http://www.ifk-cfs.de „ E-Mail: [email protected]
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CFS Working Paper No. 2008/37
Monopoly Power Limits Hedging*
Alexander Muermann1 and Stephen H. Shore2
May, 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 riskaverse 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.
* 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. 4648, A-1190 Wien, Austria, phone: +43 1 31336 4948, e-mail: [email protected]
2 Johns Hopkins University, Department of Economics, 458 Mergenthaler Hall, Baltimore, MD 21218, USA, phone: +1 410 516 5564, email: [email protected]
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Two-State Diagram
0.9
Perfect Risk Sharing
0.8
State-Wise Efficient Frontier
State-Wise Dominated
Frontier
Frontier with State-Contingent
Hedging
Proft with low demand
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
0
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0.2
0.3
0.4
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0.6
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0.8
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CFS Working Paper Series:
No.
Author(s)
Title
2008/36
Roman Inderst
Retail Finance: Bringing in the Supply Side
2008/35
Dimitris Christelis
Tullio Jappelli
Mario Padula
Cognitive Abilities and Portfolio Choice
2008/34
Tullio Jappelli
Marco Pagano
Information Sharing and Credit: Firm-Level
Evidence from Transition Countries
2008/33
Tullio Jappelli
Marco Pagano
Financial Market Integration under EMU
2008/32
Fancis X. Diebold
Georg H. Strasser
On the Correlation Structure of Microstructure
Noise in Theory and Practice
2008/31
Günter Franke
Jan Pieter Krahnen
The Future of Securitization
2008/30
Karin Assenmacher-Wesche
Stefan Gerlach
Financial Structure and the Impact of Monetary
Policy on Asset Prices
2008/29
Tobias J. Cwik
Gernot J. Müller
Maik H. Wolters
Does Trade Integration Alter Monetary Integration
2008/28
Nikolas Hautsch
Dieter Hess
Christoph Müller
Price Adjustment to News with Uncertain
Precision
2008/27
Francis X. Diebold
Canlin Li
Vivian Z. Yue
Global Yield Curve Dynamics and Interactions: A
Dynamic Nelson-Siegel Approach
Copies of working papers can be downloaded at http://www.ifk-cfs.de