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A capacitated commodity trading model with market power

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  • Martínez de Albeniz, Victor

    ()
    (IESE Business School)

  • Vendrell, Josep M.

    (IESE Business School)

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    Abstract

    In this paper we consider the problem of a trader who purchases a commodity in one market and resells it in another. The trader is capacitated: the trading volume is limited by operational constraints, e.g., logistics. The two markets quote different prices, but the spread is reduced when trading takes place. We are interested in finding the optimal trading policy across the markets so as to obtain the maximum profit in the long-term, taking into account that the trading activity influences the price processes, i.e., market power. As in the no-market-power case, we find that the optimal policy is determined by three regions, where 1) move as much as possible from one market to the other; 2) the same in the opposite direction; or 3) do nothing. Finally, we use the model to analyze kerosene price differences between New York and Los Angeles.

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    Bibliographic Info

    Paper provided by IESE Business School in its series IESE Research Papers with number D/728.

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    Length: 38 pages
    Date of creation: 07 Jan 2008
    Date of revision:
    Handle: RePEc:ebg:iesewp:d-0728

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    Related research

    Keywords: commodity trading; price processes; inventory management;

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    1. Bryan Routledge & Duane Seppi & Chester Spatt, . "Equilibrium Forward Curves for Commodities," GSIA Working Papers 1997-49, Carnegie Mellon University, Tepper School of Business.
    2. Deaton, A. & Laroque, G., 1989. "On The Behavior Of Commodity Prices," Papers 145, Princeton, Woodrow Wilson School - Development Studies.
    3. Gibson, Rajna & Schwartz, Eduardo S, 1990. " Stochastic Convenience Yield and the Pricing of Oil Contingent Claims," Journal of Finance, American Finance Association, vol. 45(3), pages 959-76, July.
    4. Roy Bailey and Marcus Chambers, . "A Theory of Commodity Price Fluctuations," Economics Discussion Papers 432, University of Essex, Department of Economics.
    5. Wang, Yunzeng, 2001. "The optimality of myopic stocking policies for systems with decreasing purchasing prices," European Journal of Operational Research, Elsevier, vol. 133(1), pages 153-159, August.
    6. Eduardo Schwartz & James E. Smith, 2000. "Short-Term Variations and Long-Term Dynamics in Commodity Prices," Management Science, INFORMS, vol. 46(7), pages 893-911, July.
    7. Deaton, Angus & Laroque, Guy, 1996. "Competitive Storage and Commodity Price Dynamics," Journal of Political Economy, University of Chicago Press, vol. 104(5), pages 896-923, October.
    8. Chester Spatt & Bryan Routledge & Duane Seppi, 1998. "The Spark Spread: An equilibrium model of the Cross-Commodity Price Relationships in Electricity," GSIA Working Papers 1999-15, Carnegie Mellon University, Tepper School of Business.
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