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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:
Publication status: Published as Holmberg, Pär and Bert Willems, 'Relaxing Competition through Speculation: Committing to a Negative Supply Slope' in Journal of Economic Theory, 2015, pages 236-266.
Handle: RePEc:hhs:iuiwop:0937
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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. 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.
  3. 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.
  4. Gilbert, Christopher L, 1997. "Manipulation of Metals Futures: Lessons from Sumitomo," CEPR Discussion Papers 1537, C.E.P.R. Discussion Papers.
  5. Holmberg, Pär & Newbery, David & Ralph, Daniel, 2009. "Supply Function Equilibria: Step Functions and Continuous Representations," Working Paper Series 788, Research Institute of Industrial Economics.
  6. James B. Bushnell & Erin T. Mansur & Celeste Saravia, 2007. "Vertical Arrangements, Market Structure, and Competition An Analysis of Restructured U.S. Electricity Markets," NBER Working Papers 13507, National Bureau of Economic Research, Inc.
  7. Jeremy Bulow & Paul Klemperer, 2002. "Prices and the Winner's Curse," RAND Journal of Economics, The RAND Corporation, vol. 33(1), pages 1-21, Spring.
  8. Ferreira, José Luis, 2000. "Strategic interaction between futures and spot markets," UC3M Working papers. Economics 7273, Universidad Carlos III de Madrid. Departamento de Economía.
  9. Bert WILLEMS & Ina RUMIANTSEVA & Hannes WEIGT, 2007. "Cournot versus supply functions: what does the data tell us?," Working Papers Department of Economics ces0720, KU Leuven, Faculty of Economics and Business, Department of Economics.
  10. Xavier Vives, 2011. "Strategic Supply Function Competition With Private Information," Econometrica, Econometric Society, vol. 79(6), pages 1919-1966, November.
  11. 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.
  12. Cédric Argenton & Bert Willems, 2011. "Exclusion through speculation," RSCAS Working Papers 2011/63, European University Institute.
  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. Cox, Charles C, 1976. "Futures Trading and Market Information," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1215-37, December.
  15. 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.
  16. 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.
  17. 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.
  18. 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.).
  19. repec:spr:compst:v:63:y:2006:i:3:p:387-411 is not listed on IDEAS
  20. 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.
  21. 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.
  22. 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.
  23. 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.
  24. 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.
  25. 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.
  26. Green, Richard, 1999. "The Electricity Contract Market in England and Wales," Journal of Industrial Economics, Wiley Blackwell, vol. 47(1), pages 107-24, March.
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