How to use demand systems to evaluate risky projects, with an application to automobile production

Friberg, Richard and Huse, Cristian (2012): How to use demand systems to evaluate risky projects, with an application to automobile production.

Abstract

This article introduces a method to quantify the effect of a firm’s strategic choices on the risk profile of its profits at different horizons. We combine a demand system for differentiated products with counterfactual paths of risk factors. Prices, costs and quantities respond endogenously to the counterfactual state of the world. The draws on risk factors are generated using copulas, in a way that flexibly can be adapted to the risks faced in various industries. We illustrate the method by studying how the US operations of German carmakers BMW and Porsche are affected by the decision to relocate production, i.e. operational hedging. We find that for plausible costs of building a plant, production in the US is attractive for BMW, but not for Porsche.

• Item Type: MPRA Paper
• Language: English
• Keywords: Exchange rate exposure, macroeconomic exposure, operational hedging, natural hedging, risk management.
• Subjects: F - International Economics > F2 - International Factor Movements and International Business > F23 - Multinational Firms ; International Business; G - Financial Economics > G3 - Corporate Finance and Governance > G32 - Financing Policy ; Financial Risk and Risk Management ; Capital and Ownership Structure ; Value of Firms ; Goodwill; L - Industrial Organization > L1 - Market Structure, Firm Strategy, and Market Performance > L16 - Industrial Organization and Macroeconomics: Industrial Structure and Structural Change ; Industrial Price Indices; L - Industrial Organization > L6 - Industry Studies: Manufacturing > L62 - Automobiles ; Other Transportation Equipment ; Related Parts and Equipment

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