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Derivatives and Default Risk

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  • Scholz, Sebastian
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    Abstract

    Upstream producers that possess market power, sell forwards with a lengthy duration to regional electricity companies (REC). As part of the liberalization of the electricity market, RECs have been privatized and exposed to a possible bankruptcy threat if spot prices have fallen below their expected value. The downstream firms’ expected profit is larger, when it is less likely to be bailed out, the effect on upstream profits is ambiguous while consumers loose. Options are less welfare increasing than forwards, but the difference is minimal. In the presence of bankruptcy, options are the preferred welfare maximizing market instrument.

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    File URL: http://epub.ub.uni-muenchen.de/11317/1/Derivatives_and_Default_Risk.pdf
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    Bibliographic Info

    Paper provided by University of Munich, Department of Economics in its series Discussion Papers in Economics with number 11317.

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    Date of creation: Jan 2010
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    Handle: RePEc:lmu:muenec:11317

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    Keywords: Forwards; Options; Default Risk; Market Efficiency;

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    2. Matti Liski & Juan-Pablo Montero, 2005. "Forward trading and collusion in oligopoly," Working Papers 0506, Massachusetts Institute of Technology, Center for Energy and Environmental Policy Research.
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    7. Powell, Andrew, 1993. "Trading Forward in an Imperfect Market: The Case of Electricity in Britain," Economic Journal, Royal Economic Society, vol. 103(417), pages 444-53, March.
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    9. David M. Kreps & Jose A. Scheinkman, 1983. "Quantity Precommitment and Bertrand Competition Yield Cournot Outcomes," Bell Journal of Economics, The RAND Corporation, vol. 14(2), pages 326-337, Autumn.
    10. Mahenc, P. & Salanie, F., 2004. "Softening competition through forward trading," Journal of Economic Theory, Elsevier, vol. 116(2), pages 282-293, June.
    11. Bushnell, James, 2007. "Oligopoly Equilibria in Electricity Contract Markets," Staff General Research Papers 13135, Iowa State University, Department of Economics.
    12. Allaz Blaise & Vila Jean-Luc, 1993. "Cournot Competition, Forward Markets and Efficiency," Journal of Economic Theory, Elsevier, vol. 59(1), pages 1-16, February.
    13. Veronika Grimm & Gregor Zoettl, 2006. "Access to Commitment Devices Reduces Investment Incentives in Oligopoly," Working Paper Series in Economics 25, University of Cologne, Department of Economics.
    14. Newbery, D. M., 1997. "Competition, Contracts and Entry in the Electricity Spot Market," Cambridge Working Papers in Economics 9707, Faculty of Economics, University of Cambridge.
    15. MURPHY, Frederic & SMEERS, Yves, 2005. "Forward markets may not decrease market power when capacities are endogenous," CORE Discussion Papers 2005028, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
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