Spot Market-Risk Market Interaction and the Protective Effects of a Tariff Under Uncertainty

Abstract

This paper discusses the interaction between commodity spot prices and secu-rity risk prices in determining the effectiveness of a protective tariff. The problem I address is that of an open economy facing price and production uncertainty in trade and having access to a securities market where claims to firms are traded. Such a description applies, for example, to Europe, Japan, the United States and many of the nations in Africa and Latin America. For these economies security prices determine industry supply decisions through their effect on market value. The paper therefore describes how risk prices are formed as distinct from commodity prices and describes their influence on tariff effectiveness in conjunction with spot prices. The model is the standard two-sector Heckscher-Ohlin model of trade except that I introduce an explicit financial sector in the market for firm securities and allow for technological uncertainty of the form