Incorporating risk fairness concerns into wine futures under quality uncertainty

Abstract

Quality uncertainty based on advance selling triggers risk aversion and risk fairness concerns by transaction parties, which have a great influence on their behaviours. From the perspective of social preference, risk fairness concerns refer to the disutility derived by a risk-averse party who cares about the risk difference between two parties, especially when one’s risk is disproportionately greater than another’s. In this paper, we develop an analytical framework to characterize the effect of consumers’ risk fairness concerns on both consumers’ and winemaker’s decisions in the context of wine futures (i.e., advance selling of wine before it is bottled). Neither the winemaker nor consumers know the real quality of the wine aging in barrels in advance. While the wine is aging in barrels, expert reviewers provide a barrel score by tasting the wine. The winemaker decides price and quantity according to the barrel score. Consumers make purchase decisions strategically in response to the winemaker’s decisions. We show how the winemaker should optimally respond to consumers’ risk fairness concerns and make optimal decisions. First, we find that with risk fairness concerns, the winemaker can induce consumers with low and high willingness-to-pay to purchase wine in two different periods. Second, consumers’ risk fairness concerns may have a positive effect on the winemaker and the optimal wine futures price may increase. Third, with capacity constraints, consumers’ risk fairness concerns always have a negative effect on the winemaker. Our findings emphasize the importance of incorporating risk fairness concerns into advance selling.