Attitudes Toward Risk and Cost Pass-Through Under Uncertainty

Abstract

This paper takes into account the difference in risk-aversion of producers to explain their degree of cost pass-through. Each producer can be either risk-neutral or risk-averse, characterized by a CARA utility function. We use our model to explain the surcharge formula in the stainless steel industry, in which American and European producers adopt 100% pass-through but Asian producers commit on zero pass-through. We find that the maximal pass-through differentiation structure arises if one supplier is risk-neutral (e.g., a Chinese state-owned enterprise) but the other is risk-averse (e.g., a domestic private enterprise). Contrarily, if both suppliers are similarly risk-averse (e.g., American vs. European producers), then the pass-through rates stay in the range of 40%-60% at market equilibrium. The presence of a risk-neutral foreign producer is an essential driver for a domestic risk-averse producer to push his pass-through rate toward an extremely high level. We also find that tariff is inefficient to promote the competitiveness of domestic producer.

Keywords: Pricing Differentiation, Risk Aversion, Pass-Through Rates, Surcharge, Stainless Steel, Import Tariff

JEL Classification: F12, F13, F61, D22, L11