Scandinavian Working Papers in Economics

Working Paper Series,
Research Institute of Industrial Economics

No 937: Relaxing Competition through Speculation: Committing to a Negative Supply Slope

Pär Holmberg () and Bert Willems
Additional contact information
Pär Holmberg: Research Institute of Industrial Economics (IFN), Postal: P.O. Box 55665, SE-102 15 Stockholm, Sweden
Bert Willems: Department of Economics, Postal: TILEC & CentER, Tilburg University

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; Speculation

JEL-codes: C73; D43; D44; G13; L13; L94

32 pages, November 7, 2012

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