Hedging Scenarios Under Competition: Exploring the Impact of Competitors' Hedging Practices

Abstract

Hedging without giving regard to what competitors are doing may actually increase the variance of profits as opposed to decreasing it. In this study, a market maker and an individual firm are taken as the players of a simultaneous game. We explore the impact of competitors' hedging practices on the optimal hedging policy of an individual firm by explicitly considering the other factors such as the level of pass-through of cost shocks and the level of profitability in the industry. Computational results are based on the simulations of an analytical model which incorporates a Nash equilibrium strategy.