Stochastic equilibria with capacity expansion : Increasing expected profit with risk aversion

Profit-maximizing firms hedge risk from uncertainty by deciding on capacity investment and production. Typically, risk-averse firms monotonically forgo expected profit in exchange for an improved risk measure, e.g., conditional value-at-risk (CVaR). However, the stochastic-equilibrium literature exhibits non-monotonicities, i.e., both CVaR and expected profit increase with risk aversion. We prove that this result arises because oligopolistic firms account for the price impacts of their own decisions but ignore those of other firms. Consequently, firms reduce capacity "too much" with risk aversion.