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What to do if a dollar is not a dollar? The impact of inflation risk on production and risk management
Author(s) -
AdamMüller Axel F. A.
Publication year - 2002
Publication title -
journal of futures markets
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.88
H-Index - 55
eISSN - 1096-9934
pISSN - 0270-7314
DOI - 10.1002/fut.10012
Subject(s) - economics , futures contract , risk aversion (psychology) , liberian dollar , speculation , production (economics) , inflation (cosmology) , risk management , financial risk management , relative price , risk premium , financial economics , expected utility hypothesis , microeconomics , macroeconomics , finance , physics , theoretical physics
An entrepreneur faces two types of risk: one from income generation, one from income spending. His incomefrom firm profits is risky due to output price fluctuations and other risks. As a consumer, he is also exposedto inflation risk since he maximizes expected utility of real income. This article focuses on optimal productionand risk management decisions of a risk‐averse entrepreneur jointly facing tradable output price risk anduntradable inflation risk. Inflation risk applies multiplicatively to the entrepreneur's entire nominalincome. Relative risk aversion and the risks' joint distribution determine the effect of introducing afutures market on production. For dependent risks, this effect may be negative if relative risk aversion isabove one. Relative risk aversion and the joint distribution also determine optimal risk management with futurescontracts where speculation on a real risk premium and cross hedging may be conflicting objectives. © 2002Wiley Periodicals, Inc. Jrl Fut Mark 22:371–386, 2002