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Forward Hedging and Vertical Integration in Electricity Markets

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  • Chemla, Gilles
  • Porchet, Arnaud
  • Touzi, Nizar
  • Aïd, René
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    Abstract

    This paper analyzes the interactions between vertical integration and (wholesale) spot, forward and retail markets in risk management. We develop an equilibrium model that fits electricity markets well. We point out that vertical integration and forward hedging are two separate levers for demand and spot price risk diversification. We show that they are imperfect substitutes as to their impact on retail prices and agents’ utility because the asymmetry between upstream and downstream segments. While agents always use the forward market, vertical integration may not arise. In addition, in presence of highly risk averse downstream agents, vertical integration may be a better way to diversify risk than spot, forward and retail mar kets. We illustrate our analysis with data from the French electricity market.

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    Bibliographic Info

    Paper provided by Paris Dauphine University in its series Economics Papers from University Paris Dauphine with number 123456789/6395.

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    Date of creation: Aug 2009
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    Handle: RePEc:dau:papers:123456789/6395

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    Related research

    Keywords: producers; hedging; forward; spot; vertical integration; retailers; electricity markets;

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    1. Levy, H & Markowtiz, H M, 1979. "Approximating Expected Utility by a Function of Mean and Variance," American Economic Review, American Economic Association, vol. 69(3), pages 308-17, June.
    2. Froot, Kenneth A & Scharfstein, David S & Stein, Jeremy C, 1993. " Risk Management: Coordinating Corporate Investment and Financing Policies," Journal of Finance, American Finance Association, vol. 48(5), pages 1629-58, December.
    3. Jean Tirole, 1988. "The Theory of Industrial Organization," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262200716, December.
    4. Williamson, Oliver E, 1971. "The Vertical Integration of Production: Market Failure Considerations," American Economic Review, American Economic Association, vol. 61(2), pages 112-23, May.
    5. Emons, W., 1990. "Good times, bad times, and vertical upstream integration," Discussion Paper 1990-23, Tilburg University, Center for Economic Research.
    6. Carlton, Dennis W, 1979. "Vertical Integration in Competitive Markets under Uncertainty," Journal of Industrial Economics, Wiley Blackwell, vol. 27(3), pages 189-209, March.
    7. Khalid Sekkat, 2006. "Vertical relationships and the firm in the global economy," ULB Institutional Repository 2013/7312, ULB -- Universite Libre de Bruxelles.
    8. Jean-Jacques Laffont & Jean Tirole, 1993. "A Theory of Incentives in Procurement and Regulation," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262121743, December.
    9. Hung-po Chao & Shmuel Oren & Robert Wilson, 2005. "Restructured Electricity Markets: A Risk Management Approach," Levine's Bibliography 784828000000000232, UCLA Department of Economics.
    10. Allaz, Blaise, 1992. "Oligopoly, uncertainty and strategic forward transactions," International Journal of Industrial Organization, Elsevier, vol. 10(2), pages 297-308, June.
    11. Chemla, Gilles, 2003. "Downstream Competition, Foreclosure, and Vertical Integration," Economics Papers from University Paris Dauphine 123456789/6313, Paris Dauphine University.
    12. Klein, Benjamin, 1988. "Vertical Integration as Organizational Ownership: The Fisher Body-General Motors Relationship Revisited," Journal of Law, Economics and Organization, Oxford University Press, vol. 4(1), pages 199-213, Spring.
    13. Paul Joskow, 1984. "Vertical Integration and Long Term Contracts: The Case of Coal Burning Electric Generating Plants," Working papers 361, Massachusetts Institute of Technology (MIT), Department of Economics.
    14. G. Chemla, 1999. "Downstream competition, foreclosure, and vertical integration," THEMA Working Papers 99-18, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
    15. Bolton, Patrick & Whinston, Michael D, 1993. "Incomplete Contracts, Vertical Integration, and Supply Assurance," Review of Economic Studies, Wiley Blackwell, vol. 60(1), pages 121-48, January.
    16. Smith, Clifford W. & Stulz, René M., 1985. "The Determinants of Firms' Hedging Policies," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(04), pages 391-405, December.
    17. Hendrik Bessembinder & Michael L. Lemmon, 2002. "Equilibrium Pricing and Optimal Hedging in Electricity Forward Markets," Journal of Finance, American Finance Association, vol. 57(3), pages 1347-1382, 06.
    18. Kenneth J. Arrow, 1975. "Vertical Integration and Communication," Bell Journal of Economics, The RAND Corporation, vol. 6(1), pages 173-183, Spring.
    19. Christian Gollier, 2004. "The Economics of Risk and Time," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262572249, December.
    20. Gilles Chemla, 2003. "Downstream Competition, Foreclosure, and Vertical Integration," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 12(2), pages 261-289, 06.
    21. Hung-po Chao & Shmuel Oren & Robert Wilson, 2005. "Restructured Electricity Markets: Reevaluation of Vertical Integration and Unbundling," Levine's Bibliography 784828000000000238, UCLA Department of Economics.
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    Cited by:
    1. Chemla, Gilles & Porchet, Arnaud & Aïd, René & Touzi, Nizar, 2011. "Hedging and vertical integration in electricity markets," Economics Papers from University Paris Dauphine 123456789/11029, Paris Dauphine University.

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