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Competitive trading in forward and spot markets under yield uncertainty

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  • Lusheng Shao
  • Derui Wang
  • Xiaole Wu

Abstract

Many agricultural commodities are traded in both forward and spot markets. This paper studies the interplay of random yield and forward market in a hybrid market with spot and forward transactions. We examine two main questions: (a) How does yield uncertainty (yield risk and yield correlation) affect the equilibrium outcome in this hybrid market? (b) How does the existence of a forward market influence the firms' strategic behaviors and spot price volatility, and how does yield uncertainty mediate the role of the forward market? In our baseline model that considers two firms and no withholding behavior by the firms, it is found that as yield risk increases, firms may sell less in the forward market, and counterintuitively, higher yield risk may benefit firms and make the spot price less volatile. The existence of a forward market leads to greater spot price volatility; that is, a forward market destabilizes spot prices. We identify a mitigating effect of yield variability, but an enhancing effect of yield correlation, on the role of the forward market. Finally, we extend our baseline model to the case with more than two firms and the setting where the firms may withhold some products and demonstrate that some of the key results in the baseline model carry over to these extensions. Nevertheless, the firms' withholding behavior represents a new driving force that changes some results. For example, the decreasing trend of spot price volatility in yield risk disappears in the withholding model.

Suggested Citation

  • Lusheng Shao & Derui Wang & Xiaole Wu, 2022. "Competitive trading in forward and spot markets under yield uncertainty," Production and Operations Management, Production and Operations Management Society, vol. 31(9), pages 3400-3418, September.
    • Handle: RePEc:bla:popmgt:v:31:y:2022:i:9:p:3400-3418
    DOI: 10.1111/poms.13769
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