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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. 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.
  2. Jeremy Bulow & Paul Klemperer, 1999. "Prices and the Winner's Curse," Game Theory and Information 9904003, EconWPA.
  3. 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.
  4. 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.
  5. repec:spr:compst:v:63:y:2006:i:3:p:387-411 is not listed on IDEAS
  6. Jordi Brandts & Paul Pezanis-Christou & Arthur Schram, 2003. "Competition with Forward Contracts: A Laboratory Analysis Motivated by Electricity Market Design," Levine's Bibliography 666156000000000172, UCLA Department of Economics.
  7. 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.
  8. Cox, Charles C, 1976. "Futures Trading and Market Information," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1215-37, December.
  9. Argenton, C. & Willems, Bert, 2010. "Exclusion Through Speculation," Discussion Paper 2010-83, Tilburg University, Center for Economic Research.
  10. 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.
  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. 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. 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.
  14. Ferreira, Jose Luis, 2003. "Strategic interaction between futures and spot markets," Journal of Economic Theory, Elsevier, vol. 108(1), pages 141-151, January.
  15. repec:dgr:kubcen:201083 is not listed on IDEAS
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