"Risk-averse firms in oligopoly," International Journal of Industrial Organization Volume 20, Issue 7, September 2002, pages 995-1012.
JEL codes: D43; D81; L13; L21
Keywords: Oligopoly; Risk aversion; Fixed costs; Strategic investment
Abstract: Does risk aversion lead to softer or fiercer competition? I show that, in general, the answer depends on whether firms set prices or quantities and if they face demand or cost uncertainty. For demand uncertainty, the risk-averse firm's best response price and quantity is lower than the corresponding risk-neutral strategy. For cost uncertainty, the best response price is higher but the best response quantity is lower. Hence, only for cost uncertainty is the expected price-cost margin unambiguously higher. It is shown that fixed costs reinforce the effects if firms have decreasing absolute risk aversion. I extend this to consider implications for strategic investment models and the importance of accumulated profits. Overall, the results emphasize that to empirically test strategic effects of risk-averse behavior it is necessary to control for the type of uncertainty.