Leonard N. Stern School of Business, New York University
Topic: "Equilibrium Forward Contracts on Nonstorable Commodities in the Presence of Market Power" Speaker: Lingxiu Dong, John M. Olin School of Business, Washington University
Date: Friday, November 21, 2003
Time: 2:30 pm - 4:00 pm
Place: 5-80 KMC
Abstract. We examine an equilibrium forward contract on a nonstorable commodity between a supplier and a manufacturer. The supplier produces the commodity, and the manufacturer uses the commodity to produce a final product. In addition to the forward contract, they can also trade in a spot market for the commodity. Both the supplier and the manufacturer are risk sensitive and have significant market power in the forward market. We model the forward contract negotiation by a Nash bargaining game and derive its unique equilibrium in closed form. We also provide extensive comparative statics and identify the hedging benefit and/or speculation benefit from the forward contract. We then calibrate our model to an electricity data set and conduct a numerical study. We find that, in contrast to a forward contract on a storable commodity, the forward price on a nonstorable commodity can be non-monotonic in the spot price; the equilibrium forward price can be lower or higher than the expected spot price, depending on the supplier's Just-in-Time capability and market power; both the equilibrium forward price volatility and the forward quantity volatility decrease as the time-to-maturity increases. Furthermore, this model suggests that for a supplier with weak Just-in-Time capability, the equilibrium forward quantity is larger for forward contracts with shorter maturities.