Scandinavian Working Papers in Economics

Memorandum,
Oslo University, Department of Economics

No 01/2007: Vertical Integration and Long-Term Contracts in Risky Markets

Fridrik M. Baldursson () and Nils-Henrik von der Fehr ()
Additional contact information
Fridrik M. Baldursson: University of Iceland
Nils-Henrik von der Fehr: Dept. of Economics, University of Oslo, Postal: Department of Economics, University of Oslo, P.O Box 1095 Blindern, N-0317 Oslo, Norway

Abstract: We consider the effects of vertical integration on the performance of long-term and spot markets when spot prices are uncertain and agents are risk averse. We find that vertical integration impairs market performance by increasing the gap between contract and (expected) spot prices. This holds regardless of whether retail prices are fixed or linked to spot prices. Depending upon the characteristics of demand and supply, vertical integration (and long-term contracting) may increase or decrease spot-price volatility.

Keywords: Vertical integration; long-term contracts; spot markets; risk aversion; electricity markets

JEL-codes: A10

37 pages, January 30, 2007

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