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Relaxing competition through speculation: Committing to a negative supply slope

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  • Holmberg, Pär
  • Willems, Bert

Abstract

We demonstrate how commodity producers can take strategic speculative positions in derivatives markets to soften competition in the spot market. In our game, producers first choose a portfolio of call options and then compete in supply functions. In equilibrium, producers sell forward contracts and buy call options to commit to downward sloping supply functions. Although this strategy is risky, it is profitable because it reduces the elasticity of the residual demand of competitors who respond by increasing mark-ups.

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  • Holmberg, Pär & Willems, Bert, 2015. "Relaxing competition through speculation: Committing to a negative supply slope," Journal of Economic Theory, Elsevier, vol. 159(PA), pages 236-266.
  • Handle: RePEc:eee:jetheo:v:159:y:2015:i:pa:p:236-266
    DOI: 10.1016/j.jet.2015.06.004
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    Cited by:

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    3. Holmberg, Pär & Tangerås, Thomas & Ahlqvist, Victor, 2018. "Central- versus Self-Dispatch in Electricity Markets," Working Paper Series 1257, Research Institute of Industrial Economics, revised 27 Mar 2019.
    4. K. Ruddell & A. B. Philpott & A. Downward, 2017. "Supply Function Equilibrium with Taxed Benefits," Operations Research, INFORMS, vol. 65(1), pages 1-18, February.
    5. Wölfing, Nikolas, 2019. "Forward trading and collusion in supply functions," ZEW Discussion Papers 19-003, ZEW - Leibniz Centre for European Economic Research.
    6. Simona Bigerna and Carlo Andrea Bollino, 2016. "Optimal Price Design in the Wholesale Electricity Market," The Energy Journal, International Association for Energy Economics, vol. 0(Bollino-M).
    7. David P. Brown & Andrew Eckert, 2018. "Analyzing the Impact of Electricity Market Structure Changes and Mergers: The Importance of Forward Commitments," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 52(1), pages 101-137, February.
    8. van Eijkel, Remco & Kuper, Gerard H. & Moraga-González, José L., 2016. "Do firms sell forward for strategic reasons? An application to the wholesale market for natural gas," International Journal of Industrial Organization, Elsevier, vol. 49(C), pages 1-35.
    9. Brown, David P. & Sappington, David E.M., 2020. "Load-Following Forward Contracts," Working Papers 2020-14, University of Alberta, Department of Economics, revised 31 Dec 2021.
    10. Sébastien Mitraille & Henry Thille, 2020. "Strategic advance sales, demand uncertainty and overcommitment," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 69(3), pages 789-828, April.
    11. Chloé Le Coq & Sebastian Schwenen, 2020. "Financial contracts as coordination device," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 29(2), pages 241-259, April.

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    More about this item

    Keywords

    Supply function equilibrium; Option contracts; Strategic commitment;
    All these keywords.

    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • L94 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Electric Utilities

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