CONTRACTING, CAPTIVE SUPPLIES, AND PRICE BEHAVIOR

Theoretical and simulation results clarify the role of procurement contracting in determining spot price levels and volatility. A generic model determines market share across quality. Actual supply is specified as price dependent and stochastic. Simulation examines the sensitivity of price level and volatility to extent of forward contracting, risk aversion, and ability to adjust spot market demand (recontracting). The results show that as forward contracting increases mean spot price decreases and variance increases. This effect increases as risk aversion decreases and as extent of recontracting adjustment in spot demand decreases.