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Relaxing competition through speculation: Committing to a negative supply slope

  • Holmberg, P.
  • Willems, B.

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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File URL: http://www.econ.cam.ac.uk/research/repec/cam/pdf/cwpe1252.pdf
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Paper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 1252.

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Date of creation: 19 Dec 2012
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Handle: RePEc:cam:camdae:1252
Contact details of provider: Web page: http://www.econ.cam.ac.uk/index.htm

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  1. Paul Klemperer & Jeremy Bulow, 1998. "Prices and the Winners Curse," Economics Series Working Papers 1998-W02, University of Oxford, Department of Economics.
  2. Willems, Bert & Rumiantseva, I. & Weigt, H., 2007. "Cournot versus Supply Functions : What Does the Data tell us?," Discussion Paper 2007-023, Tilburg University, Tilburg Law and Economic Center.
  3. Bushnell, James & Mansur, Erin T. & Saravia, Celeste, 2008. "Vertical Arrangements, Market Structure and Competition: An Analysis of Restructured U.S. Electricity Markets," Staff General Research Papers Archive 13130, Iowa State University, Department of Economics.
  4. Cédric Argenton & Bert Willems, 2011. "Exclusion through speculation," RSCAS Working Papers 2011/63, European University Institute.
  5. Cox, Charles C, 1976. "Futures Trading and Market Information," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1215-37, December.
  6. Pär 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.
  7. Gilbert, Christopher L, 1997. "Manipulation of Metals Futures: Lessons from Sumitomo," CEPR Discussion Papers 1537, C.E.P.R. Discussion Papers.
  8. Leonard Cheng, 1985. "Comparing Bertrand and Cournot Equilibria: A Geometric Approach," RAND Journal of Economics, The RAND Corporation, vol. 16(1), pages 146-152, Spring.
  9. Holmberg, P. & Newbery, D & Ralph, D., 2008. "Supply Function Equilibria: Step Functions and Continuous Representations," Cambridge Working Papers in Economics 0863, Faculty of Economics, University of Cambridge.
  10. Anderson, Edward J. & Hu, Xinmin, 2008. "Forward contracts and market power in an electricity market," International Journal of Industrial Organization, Elsevier, vol. 26(3), pages 679-694, May.
  11. Markus Reisinger & Ludwig Ressner, 2009. "The Choice of Prices versus Quantities under Uncertainty," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 18(4), pages 1155-1177, December.
  12. Von Der Fehr, N.H.M. & Harbord, D., 1992. "Long-Tern Contracts and Imperfectly Competitive Spot Markets : A Study of U.K. Electricity Industry," Memorandum 14/1992, Oslo University, Department of Economics.
  13. Ferreira José Luis, 2006. "The Role of Observability in Futures Markets," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 6(1), pages 1-22, June.
  14. Jordi Brandts & Paul Pezanis-Christou & Arthur Schram, 2003. "Competitions with Forward Contracts: A Laboratory Analysis Motivated by Electricity Market Design," Working Papers 66, Barcelona Graduate School of Economics.
  15. Xavier Vives, 2009. "Strategic Supply Function Competition with Private Information," CESifo Working Paper Series 2856, CESifo Group Munich.
  16. Wayne D. Greenstone, 1981. "The coffee cartel: Manipulation in the public interest," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 1(1), pages 3-16, 03.
  17. Hendrik Bessembinder & Michael L. Lemmon, 2002. "Equilibrium Pricing and Optimal Hedging in Electricity Forward Markets," Journal of Finance, American Finance Association, vol. 57(3), pages 1347-1382, 06.
  18. Green, Richard, 1999. "The Electricity Contract Market in England and Wales," Journal of Industrial Economics, Wiley Blackwell, vol. 47(1), pages 107-24, March.
  19. George M. Korniotis, 2009. "Does speculation affect spot price levels? the case of metals with and without futures markets," Finance and Economics Discussion Series 2009-29, Board of Governors of the Federal Reserve System (U.S.).
  20. 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.
  21. repec:spr:compst:v:63:y:2006:i:3:p:387-411 is not listed on IDEAS
  22. Bulow, Jeremy I & Geanakoplos, John D & Klemperer, Paul D, 1985. "Multimarket Oligopoly: Strategic Substitutes and Complements," Journal of Political Economy, University of Chicago Press, vol. 93(3), pages 488-511, June.
  23. John C. Harsanyi & Reinhard Selten, 1988. "A General Theory of Equilibrium Selection in Games," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262582384, December.
  24. Ali Hortaçsu & Steven L. Puller, 2008. "Understanding strategic bidding in multi-unit auctions: a case study of the Texas electricity spot market," RAND Journal of Economics, RAND Corporation, vol. 39(1), pages 86-114.
  25. Ferreira, José Luis, 2000. "Strategic interaction between futures and spot markets," UC3M Working papers. Economics 7273, Universidad Carlos III de Madrid. Departamento de Economía.
  26. Edward Anderson & Huifu Xu, 2006. "Optimal Supply Functions in Electricity Markets with Option Contracts and Non-smooth Costs," Mathematical Methods of Operations Research, Springer;Gesellschaft für Operations Research (GOR);Nederlands Genootschap voor Besliskunde (NGB), vol. 63(3), pages 387-411, July.
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