Portfolio Choice, Transactions Costs and Monopoly Power

Abstract

By using optimal stochastic control, where risk can be reduced by appropriate efforts, monopoly power is shown to engender reduced efforts to lower risk. It therefore gives rise to a relatively high ratio of liquid assets to net wealth. Furthermore, a decline in demand is shown to generally elicit increased efforts to reduce risk and thus yields an augmented share of risk bearing assets in the portfolio. These predictions are corroborated by invoking empirical evidence that pertains to West German industries. It thus appears that a capitalist economy is characterized by a built-in-mechanism stabilizing macroeconomic activity. This mechanism, however, is attenuated by monopoly power. That provides an additional rationale for competition policy.

Helpful comments on previous drafts by Armin Frisch, Rainer Klump, Doris Neuberger, Karl W. Roskamp, and F.A. Schmid are gratefully acknowledged. Jürgen Weigand provided excellent research assistance. Remaining errors are due to the author.