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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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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
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  1. Jordi Brandts & Paul Pezanis-Christou & Arthur Schram, 2003. "Competition with Forward Contracts: A Laboratory Analysis Motivated by Electricity Market Design," UFAE and IAE Working Papers 581.03, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
  2. James B. Bushnell & Erin T. Mansur & Celeste Saravia, 2008. "Vertical Arrangements, Market Structure, and Competition: An Analysis of Restructured US Electricity Markets," American Economic Review, American Economic Association, vol. 98(1), pages 237-66, March.
  3. 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.
  4. 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.
  5. 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.
  6. 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.
  7. Ferreira, Jose Luis, 2003. "Strategic interaction between futures and spot markets," Journal of Economic Theory, Elsevier, vol. 108(1), pages 141-151, January.
  8. Xavier Vives, 2008. "Strategic Supply Function Competition with Private Information," CESifo Working Paper Series 2410, CESifo Group Munich.
  9. Argenton, C. & Willems, Bert, 2010. "Exclusion Through Speculation," Discussion Paper 2010-83, Tilburg University, Center for Economic Research.
  10. Jeremy Bulow & Paul Klemperer, 1999. "Prices and the Winner's Curse," Game Theory and Information 9904003, EconWPA.
  11. 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.
  12. 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.
  13. Green, Richard, 1999. "The Electricity Contract Market in England and Wales," Journal of Industrial Economics, Wiley Blackwell, vol. 47(1), pages 107-24, March.
  14. Edward Anderson & Huifu Xu, 2006. "Optimal Supply Functions in Electricity Markets with Option Contracts and Non-smooth Costs," Mathematical Methods of Operations Research, Springer, vol. 63(3), pages 387-411, July.
  15. 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, June.
  16. Gilbert, Christopher L, 1997. "Manipulation of Metals Futures: Lessons from Sumitomo," CEPR Discussion Papers 1537, C.E.P.R. Discussion Papers.
  17. 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.
  18. 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.
  19. 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.
  20. repec:spr:compst:v:63:y:2006:i:3:p:387-411 is not listed on IDEAS
  21. 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.).
  22. 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.
  23. 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.
  24. Cox, Charles C, 1976. "Futures Trading and Market Information," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1215-37, December.
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