Leaders, Followers, and Risk Dynamics in Industry Equilibrium
Murray Carlson, Engelbert J. Dockner, Adlai Fisher, Ron Giammarino
Journal of Financial and Quantitative Analysis · 2014 · Volume 49 · Issue 2
DOI: 10.1017/S0022109014000337
Abstract
We study the distinct impacts of own and rival actions on risk and return when firms strategically compete in the product market. Contrary to simple intuition, a competitor’s options to adjust capacity reduce own-firm risk. For example, if a rival possesses a growth option, an increase in industry demand directly enhances profits but also encourages value-reducing competitor expansion. The rival option thus acts as a natural hedge. Within the industry, we obtain endogenous differences in expected returns. In a leader-follower equilibrium, own-firm and competitor risks and required returns move together through contractions and oppositely during expansions, providing testable new predictions.
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