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Relaxing Competition through Speculation: Committing to a Negative Supply Slope

  • Holmberg, Pär

    ()

    (Research Institute of Industrial Economics (IFN))

  • Willems, Bert

    (Department of Economics)

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 Research Institute of Industrial Economics in its series Working Paper Series with number 937.

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Length: 32 pages
Date of creation: 07 Nov 2012
Date of revision:
Handle: RePEc:hhs:iuiwop:0937
Contact details of provider: Postal: Research Institute of Industrial Economics, Box 55665, SE-102 15 Stockholm, Sweden
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  1. repec:dgr:kubcen:201083 is not listed on IDEAS
  2. Paul Klemperer & Jeremy Bulow, 1998. "Prices and the Winners Curse," Economics Series Working Papers 1998-W02, University of Oxford, Department of Economics.
  3. Cédric Argenton & Bert Willems, 2011. "Exclusion through speculation," RSCAS Working Papers 2011/63, European University Institute.
  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. 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.
  6. 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.
  7. repec:spr:compst:v:63:y:2006:i:3:p:387-411 is not listed on IDEAS
  8. 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.
  9. Jordi Brandts & Paul Pezanis-Christou & Arthur Schram, 2008. "Competition with forward contracts: a laboratory analysis motivated by electricity market design," Economic Journal, Royal Economic Society, vol. 118(525), pages 192-214, 01.
  10. 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.
  11. 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.
  12. Ferreira, Jose Luis, 2003. "Strategic interaction between futures and spot markets," Journal of Economic Theory, Elsevier, vol. 108(1), pages 141-151, January.
  13. José Luis Ferreira, 2001. "The Role Of Observability In Futures Markets," Economics Working Papers we015316, Universidad Carlos III, Departamento de Economía.
  14. 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.
  15. 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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