Forward Commodity Trading with Private Information

Abstract

Firms that trade a commodity that has a random price can reduce risk by trading forward. In “Forward Commodity Trading with Private Information,” Edward J. Anderson and Andrew B. Philpott consider a setting in which a buyer and a seller of a divisible commodity have different private information on the probability distribution of its future price. This situation arises in electricity pool markets where contracts for differences are traded by buyers and sellers of electricity to hedge future price risk. The paper compares several mechanisms for settling the price and quantity of such a contract when buyers and sellers have private information. These include Nash bargaining and supply- function equilibrium models. In the latter setting, a player can deduce the other player’s private information from its offered supply function and use this to improve its own supply function. Examples are given to show that this strategy, when used by both firms, may make both firms worse off in equilibrium.