Production and insurance under regret aversion

This paper examines the behavior of a regret-averse producer facing revenue risk. To insure against the revenue risk, the producer can purchase a coinsurance contract with an endogenously chosen coinsurance rate. Regret-averse preferences are characterized by a utility function that includes disutility from having chosen ex-post suboptimal alternatives. We show that the regret-averse producer never fully insures against the revenue risk even though the coinsurance contract is actuarially fair. When the producer is sufficiently regret averse and the loss probability is high, we further show that the regret-averse producer chooses not to purchase the actuarially fair coinsurance contract. Even when purchasing the actuarially fair coinsurance contract is optimal, we derive sufficient conditions under which the regret-averse producer reduces the optimal output level as compared to that without the coinsurance contract. These results are distinct from those under pure risk aversion, thereby making the consideration of regret aversion crucial.     

Export and Strategic Currency Hedging

This paper examines an international Cournot duopoly wherein a home firm and a foreign firm compete in the home market under exchange rate uncertainty. The foreign exporting firm, being risk averse, has incentives to hedge its exchange rate risk exposure. In a two-stage setting, we show that hedging via an unbiased currency futures market acts as a strategic device. In particular, under either constant or decreasing absolute risk aversion, an increase in the hedging volume of the foreign firm promotes its exports and deters the home firm’s output. In contrast to the well-known full-hedging result in a perfectly competitive environment, we find that the foreign firm over-hedges for strategic reasons. Furthermore, the separation result from the hedging literature under perfect competition no longer holds in our duopoly framework, i.e., equilibrium output levels depend on the risk attitude of the foreign firm as well as the probability distribution of the spot exchange rate.     

David Pearce and the economic valuation of biodiversity

David Pearce was a pioneer in the economic valuation of biodiversity. His work powerfully influenced both later economists who worked in the field and natural scientists and practitioners who gained and appreciation of the importance of economics to their efforts. Pearce often applied the paradigm of demonstration followed by appropriation: the values of biodiversity must first be demonstrated to those who make decisions concerning its survival, and then appropriated by them. The later step will be possible when market and policy failures are rectified so as to allow the realization of conservation values. While Pearce wrote extensively on these themes, he was also acutely aware of the limitations of the paradigm. Rosy projections of values that could not be realized and appropriated would be of little practical use, and Pearce often cautioned against excesses of optimism. Yet he also clearly believed that there are compelling, if not always easily demonstrated, reasons for conservation. I argue in this paper that Pearce’s seminal work on the valuation of biodiversity cannot be understood without some appreciation of his philosophical perspective. Pearce would have described himself as a pragmatist. However, his pragmatism was grounded in the belief that it is both expedient and ethical to recognize that communities in some of the poorest corners of the world will only conserve biodiversity if they are justly compensated for the sacrifices they must make to do so. Associate Professor of International Policy, Paul H. Nitze School of Advanced International Studies, Johns Hopkins University; Economist, National Center for Environmental Economics, United States Environmental Protection Agency; and Research Associate, Elliott School of International Studies, George The opinions expressed here are those of the author, and do not necessarily express the views of the United States Environmental Protection Agency.     

The Production Responses of the Competitive Firm to Three Conventional Distributional Shifts: a Unified Perspective

This paper presents a unified perspective on the production responses of the competitive firm to three conventional distributional shifts: (i) a rightward shift of the distribution, (ii) a Rothschild–Stiglitz increase in risk, and (iii) a Menezes et al. increase in downside risk. In particular, assuming that the von Neumann–Morgenstern utility is increasing and concave, and assuming its higher‐order derivatives are uniformly signed, we demonstrate that the production responses are unambiguous in the case of price less than or equal to marginal cost. In the alternative case of price greater than marginal cost, we then demonstrate that the production responses can be signed unambiguously by reference to sufficient conditions motivated by absolute risk aversion and by absolute prudence.     

Attitudes of food entrepreneurs towards two grant schemes under the first England Rural Development Programme, 2000–2006

Grant schemes introduced under the first England Rural Development Programme (ERDP) (2000–2006) have been subjected to limited academic research and this paper aims to fill this gap by examining the attitudes of food entrepreneurs in two contiguous English regions to two key elements of the ERDP: the Processing and Marketing Grant (PMG) and the Rural Enterprise Scheme (RES). It does this through a qualitative analysis of data gathered from interviews with 20 ‘adopters’ and 20 ‘non-adopters’ of the two schemes in the South West and West Midlands regions of England. The analysis reveals that, despite the rural development rhetoric, neither the PMG nor the RES was particularly effective at funding enterprises beyond the farm gate; both schemes also appeared to attract what can be described as ‘serial adopters’ and to discriminate against those without experience of applying for government grants. Nevertheless, indirectly they did provide opportunities to safeguard and expand local and regional food production, processing and retailing in the two regions.     

CVP under Uncertainty and the Manager's Utility Function Revisited

This paper re-examines the model of Kim, Abdolmohammada, and Klein (KAK, 1996) in which owners of a firm delegate the production decision to a risk-averse manager. Conflict of interest between the owners and the manager emerges as the latter maximizes the expected utility of his/her own wealth rather than that of the firm's profits. This paper shows that the results of KAK on the expected contribution margin and the excess return on the risky asset are flawed. Furthermore, while KAK study the effects of delegating the production decision to the manager on the firm's optimal output based on the mean-variance analysis, this paper derives parallel results within utility functions exhibiting constant absolute risk aversion and any arbitrary probability distribution functions.     

MANAGERIAL INCENTIVES AND THE USE OF FOREIGN‐EXCHANGE DERIVATIVES BY BANKS

We examine the effect of managerial compensation and ownership on the use of foreign‐exchange derivatives by U.S. bank holding companies. We focus on derivatives used for purposes other than trading to investigate derivative use in a hedging framework. We use instrumental variables probit and sample‐selection models to estimate the effects of endogenous and exogenous factors on the probability and extent of foreign‐exchange derivatives used. We find that the use of derivatives is inversely related to option awards but positively related to managerial ownership. Finally, our results suggest that ownership by large institutional shareholders provides incentive for managers to hedge.     

Option Compensation and Industry Competition

Compensation policy has become one of the most important ingredientsof corporate governance. In this paper we take a new look atthe issue, by contrasting the use of options with that of stock.We do this by integrating the repricing or resetting aspectof options with that of industrial structure. We show that industrycompetition may play an important role in dictating which formof compensation is optimal. When aggressive competition forkey professional staff is an issue, the flexibility of optionsmay actually become a disadvantage and therefore pure stockcompensation may survive as an equilibrium. Thus compensationtrends may be partly explained by trends in the nature of thecompetitive environment.