Relaxing Competition through Speculation

Committing to a Negative Supply Slope

P. Holmberg, Bert Willems

Research output: Working paperDiscussion paperOther research output

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Abstract

Abstract: 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.
Original languageEnglish
Place of PublicationTilburg
PublisherEconomics
Number of pages33
Volume2012-088
Publication statusPublished - 2012

Publication series

NameCentER Discussion Paper
Volume2012-088

Fingerprint

Speculation
Call option
Suppliers
Elasticity
Spot market
Forward contracts
Markups
Derivative markets
Competitors
Commodity prices

Keywords

  • Supply function equilibrium
  • Option contracts
  • Strategic commitment
  • Speculation

Cite this

Holmberg, P., & Willems, B. (2012). Relaxing Competition through Speculation: Committing to a Negative Supply Slope. (CentER Discussion Paper; Vol. 2012-088). Tilburg: Economics.
Holmberg, P. ; Willems, Bert. / Relaxing Competition through Speculation : Committing to a Negative Supply Slope. Tilburg : Economics, 2012. (CentER Discussion Paper).
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Holmberg, P & Willems, B 2012 'Relaxing Competition through Speculation: Committing to a Negative Supply Slope' CentER Discussion Paper, vol. 2012-088, Economics, Tilburg.

Relaxing Competition through Speculation : Committing to a Negative Supply Slope. / Holmberg, P.; Willems, Bert.

Tilburg : Economics, 2012. (CentER Discussion Paper; Vol. 2012-088).

Research output: Working paperDiscussion paperOther research output

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AU - Willems, Bert

N1 - Pagination: 33

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N2 - Abstract: 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.

AB - Abstract: 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.

KW - Supply function equilibrium

KW - Option contracts

KW - Strategic commitment

KW - Speculation

M3 - Discussion paper

VL - 2012-088

T3 - CentER Discussion Paper

BT - Relaxing Competition through Speculation

PB - Economics

CY - Tilburg

ER -

Holmberg P, Willems B. Relaxing Competition through Speculation: Committing to a Negative Supply Slope. Tilburg: Economics. 2012. (CentER Discussion Paper).