Holmberg, P. and Willems, B.

Relaxing competition through speculation: Committing to a negative supply slope

CWPE1252

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.

Keywords: Supply function equilibrium, Option contracts, Strategic commitment

JEL Codes: JC73 D43 D44 G13 L13 L94

PDF: https://www.econ.cam.ac.uk/research-files/repec/cam/pdf/cwpe1252.pdf

EPRG Paper Link: 1224

Open Access Link: https://doi.org/10.17863/CAM.1011

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