Endogenous fixprices and sticky price adjustment of risk-averse firms

Abstract

A risk-averse price-setting firm which knows the quantity demanded at the status quo price but has imperfect information otherwise may choose not to change it although an otherwise identical risk-neutral firm would do so, provided the variance of the firm's subjective probability distribution over quantities demanded as a function of price displays a kink at the status quo. This is equivalent to risk aversion of order one. When no such endogenous fixprice exists, the size of price adjustment still tends to zero as risk aversion tends to infinity, and to any arbitrarily small menu cost there exists a degree of risk aversion so that the firm will not adjust.