Abstract
AbstractWe study the use of financial contracts as bid‐coordinating device in multi‐unit uniform price auctions. Coordination is required whenever firms face a volunteer's dilemma in pricing strategies: one firm (the “volunteer") is needed to increase the market clearing price. Volunteering, however, is costly, as inframarginal suppliers sell their entire capacity whereas the volunteer only sells residual demand. We identify conditions under which signing financial contracts solves this dilemma. We test our framework exploiting data on contract positions by large producers in the New York power market. Using a Monte Carlo simulation, we show that the contracting strategy is payoff dominant and provide estimates of the benefits of such strategy.
Highlights
A variety of goods and services are traded in multi-unit auctions
The theoretical literature on strategic forward trading shows that forward contracts a↵ect spot market prices, either by enhancing or softening spot market competition (e.g., Allaz and Vila (1993), Mahenc and Salanie (2004))
We can conclude that the two large firms would face a volunteer’s dilemma in the absence of a contract
Summary
A variety of goods and services are traded in multi-unit auctions. Classic examples include auctions for government bonds (Hortacsu et al (2018)), spectrum rights (Cramton and Ockenfels (2017)), electricity (Fabra et al (2006)), carbon emissions allowances (Lopomo et al (2011)), or gas pipeline capacity (Newbery (2002)). An example that seems to contradict the extant findings, was observed in the New York power market, which operates as a multi-unit uniform price auction. Whereas two major producers signed forward contracts in 2006, the market price stayed equal to the regulatory price cap before and after the contract start date. Both the US Federal Energy Regulatory Commission (FERC) and the Department of Justice (DOJ) investigated whether the contractual agreements constituted market manipulation. DOJ (2010), following Cramton (2007), found that the contracts helped firms to avoid competitive bidding strategies
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