Financial hedging and competitive strategy for value-maximizing firms under quantity competition

Abstract

Inspired by the growing use of financial hedging among competitive firms nowadays, we develop a game-theoretical model to investigate the problem of applying financial hedging to improve a firm’s competitive strategy. A distinctive setting of the model is that the firm value is a concave function of the firm profit, which is consistent with the empirical evidences in finance literature. After proving the unique existence of the Nash equilibrium, we examine the effects of financial hedging on the equilibrium and yield some novel results. In particular, our analysis suggests that in a competitive market, financial hedging is not just to protect a firm’s bottom line; perhaps more importantly, effective financial hedging schemes can help increase the firm value by boosting the firm’s production, raising the market share, and improving its profitability.