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Relaxing Competition through Speculation: Committing to a Negative Supply Slope

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  • Holmberg, Pär

    ()
    (Research Institute of Industrial Economics (IFN))

  • Willems, Bert

    (Department of Economics)

Abstract

We demonstrate how suppliers can take strategic speculative positions in derivatives markets to soften competition in the spot market. In our game, suppliers first choose a portfolio of call options and then compete with supply functions. In equilibrium firms sell forward contracts and buy call options to commit to downward sloping supply functions. Although this strategy is risky, it reduces the elasticity of the residual demand of competitors, who increase their mark-ups in response. We show that this type of strategic speculation increases the level and volatility of commodity prices and decreases welfare.

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Bibliographic Info

Paper provided by Research Institute of Industrial Economics in its series Working Paper Series with number 937.

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Length: 32 pages
Date of creation: 07 Nov 2012
Date of revision:
Handle: RePEc:hhs:iuiwop:0937

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Postal: Research Institute of Industrial Economics, Box 55665, SE-102 15 Stockholm, Sweden
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Web page: http://www.ifn.se/
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Keywords: Supply function equilibrium; Option contracts; Strategic commitment; Speculation;

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  6. de Frutos, María-Ángeles & Fabra, Natalia, 2012. "How to allocate forward contracts: The case of electricity markets," European Economic Review, Elsevier, vol. 56(3), pages 451-469.
  7. P�r Holmberg, 2011. "Strategic Forward Contracting in the Wholesale Electricity Market," The Energy Journal, International Association for Energy Economics, vol. 0(Number 1), pages 169-202.
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