“What to do if a dollar is not a dollar? The impact of inflation risk on production and risk management” by Axel F.A. Adam-Mueller
Axel F.A. Adam-Mueller
University of Konstanz
An entrepreneur faces two types of risk, one from income generation, one from income spending. His income from firm profits is risky due to output price fluctuations and other risks. As a consumer, he is also exposed to inflation risk since he maximizes expected utility of real income. This paper focuses on optimal production and risk management decisions of a risk-averse entrepreneur jointly facing tradable output price risk and untradable inflation risk. Relative risk aversion and the risks' joint distribution determine the effect of introducing a futures market on production. This effect may be negative as illustrated by a numerical example. They also determine optimal risk management with futures contracts where speculation on a real risk premium and cross hedging may be conflicting objectives.