On the Extension of the Kiyotaki and Wright model to Transformable Goods

Abstract

In this paper we extend the classical Kiyotaki and Wright (KW) model and consider a transformable good. Such an extension enables us to adapt the model to the specific conditions of the wine market. The most important change, with respect to the original model, is that one type of good (young wine, in our model) can improve its quality and thereby transform to another type of good (old wine). However, there is a certain probability that such transformation may not be successful and the good under consideration may simply spoil. We adapt the main KW theoretical features to the study of speculative strategies in a stylized wine market. This study can be generalized to other commodity markets in which goods are unstable and present intrinsic properties such as quality increase or decrease across time. These markets are also typically characterized by roles or types of agents, such as producers, merchants and consumers, whose interests lack double coincidence when they meet. We define a general model and then use simulation methods to systematically study under which conditions speculative strategies are possible in this setting and which is the most efficient distribution of types of agents under speculative equilibria. The theoretical results are also provided for the model, with equal numbers of agents of different types, similarly to the Kiyotaki and Wright original paper.