Forward Commitments Research Articles

Why graduates really do matter

The government's decision to not take forward commitments in its workforce strategy are, of course, disappointing, but should we be surprised that once again rhetoric is rarely backed with real policy?

Market Power and Forward Prices

We construct a model of strategic behavior in sequential markets which exhibits a persistent forward price premium. On the spot market, producers wield market power while purchasers are price takers. Producers with forward commitments have less incentive to raise prices on the spot market. Purchasers are thus willing to pay a premium to producers for forward contracts. We argue that this type of forward premium is not susceptible to arbitrage by speculators on the forward market, since purchasers prefer forward contracts backed by producers.

Analyzing the Impact of Electricity Market Structure Changes and Mergers: The Importance of Forward Commitments

We investigate how the effects of market structure changes and mergers in restructured electricity markets depend on the level of forward contracting. We develop a Cournot model of Alberta’s wholesale electricity market that incorporates firms’ forward positions. Using data from 2013 to 2014, we calibrate the forward positions of the five largest firms and simulate the effects of different market structure changes, including a hypothetical merger with asset divestitures. We examine the sensitivity of the simulated effects to assumptions with regard to the firms’ forward commitments. The wholesale market effects of these transactions depend critically on firms’ forward commitments. These results demonstrate the importance of establishing a clear understanding of the size and nature of forward commitments in forecasting the effects of mergers and other market structure changes in wholesale electricity markets.

Electricity market mergers with endogenous forward contracting

We analyze the effects of electricity market mergers in an environment where firms endogenously choose their level of forward contracts prior to competing in the wholesale market. We apply our model to Alberta’s wholesale electricity market. Firms have an incentive to reduce their forward contract coverage in the more concentrated post-merger equilibrium. We demonstrate that endogenous forward contracting magnifies the price increasing impacts of mergers, resulting in larger reductions in consumer surplus. Current market screening procedures used to analyze electricity mergers consider firms’ pre-existing forward commitments. We illustrate that ignoring the endogenous nature of firms’ forward commitments can yield biased conclusions regarding the impacts of market structure changes such as mergers. In particular, we show that the price effects of mergers can be largely underestimated when forward contract quantities are held at pre-merger levels. Whether the profits of the merged firm are greater with fixed or endogenous forward quantities is ambiguous.

Electricity Market Mergers with Endogenous Forward Contracting

We analyze the effects of electricity market mergers in an environment where firms endogenously choose their level of forward contracts prior to competing in the wholesale market. We apply our model to Alberta’s wholesale electricity market. Firms have an incentive to reduce their forward contract coverage in the more concentrated post-merger equilibrium. We demonstrate that endogenous forward contracting magnifies the price increasing impacts of mergers, resulting in larger reductions in consumer surplus. Current market screening procedures used to analyze electricity mergers consider firms’ preexisting forward commitments. We illustrate that ignoring the endogenous nature of firms’ forward commitments can yield biased conclusions regarding the impacts of market structure changes such as mergers. In particular, we show that the price effects of mergers can be largely underestimated when forward contract quantities are held at pre-merger levels. Whether the profits of the merged firm are greater with fixed or endogenous forward quantities is ambiguous.

Analyzing the Impact of Electricity Market Structure Changes and Mergers: The Importance of Forward Commitments

We investigate how the effects of market structure changes and mergers in restructured electricity markets depend on the level of forward contracting. Following Bushnell, Mansur, and Saravia (2008), we develop a Cournot model of Alberta’s wholesale electricity market that incorporates firms’ forward positions. Using data from 2013-2014, we estimate the monthly forward positions of the five largest firms in the market, and simulate the effects of different market structure changes, including variations of a hypothetical merger with asset divestitures. We examine the sensitivity of the simulated effects of mergers and other market structure changes to assumptions regarding firms’ forward commitments. We demonstrate that the wholesale market impacts of mergers and market structure changes depend critically on firms’ forward commitments in the post market structure change equilibrium. Our paper demonstrates the importance of establishing a clear understanding of the size and nature of forward commitments in forecasting the effects of mergers and other market structure changes in wholesale electricity markets.

A market-based martingale valuation approach to optimum inventory control in a doubly stochastic jump-diffusion economy

We propose a novel market-based approach to optimum inventory control in a doubly stochastic jump-diffusion economy by modelling a commodity distributor’s inventory investment as a portfolio of forward commitments with explicit accounting of the jump-diffusion dynamics of demands, costs, and prices in open markets. We apply the robust real-asset martingale valuation methodology to derive a closed-form solution for the inventory value and a simple and intuitive optimality condition. Numerical analysis verifies this condition and demonstrates that the resulting optimum policy has robust properties in relation to the stylized effects.

Resource externalities and the persistence of heterogeneous pricing behavior in an energy commodity market

In competitive product markets, repeated interaction among producers with similar economic characteristics would be expected to result in convergence of their behaviors. If convergence does not occur, it raises fundamental questions related to the sustainability of heterogeneous competitive strategies. This paper examines the prices submitted to the British wholesale electricity market by four coal-fired plants, separately owned, approximately of the same age, size and efficiency, and located in the same transmission network zone. Due to the repetitive nature of the spot market, one would expect convergence in strategies. Yet, we find evidence of persistent price dispersion and heterogeneous strategies. We consider several propositions for these effects including market power, company size, forward commitments, vertical integration and the management of interrelated assets.

Two Concepts of Liberty: U.S. Cold War Grand Strategies and the Liberal Tradition

Contrary to conventional accounts, the United States did not immediately adopt a set of sweeping commitments to Europe after World War II. Instead, it pursued a buck-passing strategy until the early 1960s that sought to craft Western Europe into an independent pole of power capable of balancing the Soviet Union largely without the assistance of the United States, thereby facilitating the withdrawal of U.S. troops from the continent. Only under President John F. Kennedy did the United States adopt a balancing strategy, making permanent forward commitments to the defense of Europe. A new theory of liberal ideas and foreign policy explains this shift. “Negative liberals,” who see freedom in terms of opportunity and minimal state intervention, adopted a buck-passing strategy to pass the costs of foreign policy to other actors and minimize state intrusion at home. “Positive liberals,” who see freedom as the exercise of capabilities and often welcome state intervention, had no such compunctions. Starting with Kennedy, positive liberals welcomed firmer balancing commitments in part as a measure to protect the liberal regimes that had emerged in Western Europe after World War II.

Optimal self-scheduling of a dominant power company in electricity markets

This paper addresses the problem of the self-scheduling of a power company with a dominant role in both the production and retail sectors of an electricity market. An integrated 0/1 mixed integer linear programming (MILP) formulation is provided, which combines both thermal and hydro subsystems in a single portfolio for a dominant power company through a detailed modeling of the operating constraints of thermal units and hydroplants. Residual demand curves for energy and reserves are used to model the effect of the power company’s interactions with its competitors. Test results on a medium-scale real test system address the effect that the power company’s forward commitments and the market rules have on its daily self-scheduling and profits as well as on the resulting energy and reserve market clearing prices.

Interdependence through time: relationships in post-Keynesian thought and the care literature

Does Hyman Minsky's 'general interdependence through time' have anything to do with Carol Gilligan's 'narrative of relationships that extends over time'? Both post-Keynesian theory and the feminist 'care literature' embrace calendar time and fundamental uncertainty. Both investigate the properties of networks of wittingly-formed forward commitments between actors. If some prominent writers in the care literature are right, these networks merit their own social-ontological status, because they are reducible neither to individual behaviour nor structure.

U.S. Exit Strategies and Zero Interest Rates

The wholesale interbank market (where banks trade with each other) reduces the risk for banks making forward commitments to lend at retail–to households and firms, including exporters and importers. The collapse of the U.S. housing bubble in 2007–08 impaired bank balance sheets so that banks became reluctant to lend to each other from counterparty risk. Retail bank credit fell sharply, thus worsening the crisis. By 2009, the U.S. government had responded by recapitalizing large commercial banks and by flooding the system with liquidity so as to drive short-term interest rates close to zero. Although counterparty risk is now in abeyance, forcing short-term interest rates at zero is a serious mistake. Wholesale interbank lending is still inhibited so that retail bank credit is unlikely to recover–and continues to fall in 2009.

Option and forward contracting with asymmetric information: Valuation issues in supply chains

We investigate the role of forward commitments and option contracts between a seller (supplier) and a buyer (retailer) in the presence of asymmetric information. In our case, both parties face price and demand uncertainty but the retailer, being closer to the market, has additional information about the true demand and price. The supplier, aware of this asymmetry, and acting as a Stackelberg leader, designs a contracting arrangement that best meet his interest. We contrast the role of forward and option contracts in this environment and identify cases where combinations of the two are dominant. Finally, we investigate how alternative contracting arrangements alter the expected value of obtaining information that eliminates asymmetric information.

Electricity Producer Offering Strategies in Day-Ahead Energy Market With Step-Wise Offers

This paper addresses the problem of the development of optimal offering strategies by electricity producers in day-ahead energy auctions with step-wise energy offer format. The producer energy offer optimization is formulated as a bi-level optimization problem, which is converted to a offer optimization is formulated as a bi-level optimization problem, which is converted to a mathematical program with equilibrium constraints (MPEC). The producer MPEC is subsequently converted to a mixed integer linear program (MILP) using binary expansion of offer quantities and prices. The uncertainties under which the producer must develop his offering strategy are modeled. Test results on a small, ten-unit test system address the effect of the auction settlement rules (uniform or discriminatory pricing) as well as the producer's forward commitments on the producer strategic behavior in the day-ahead energy market.

Editors' Overview

Editors' Overview

Credible Forward Commitments and Risk-Sharing Equilibria

It is shown that risk-sharing examined in Rothschild and Stiglitz (1976) has a perfect Nash equilibrium, which is unique, incentive-efficient and continuous in all parameters of the economy. Competition in individual markets of a perfectly competitive economy is generally imperfect and allows for cross-market subsidies. Contrary to the commonly accepted view, buyer's valuation of a contract cannot be identified with her valuation of consumption stipulated by that contract. A promise of future performance by a seller lacks credibility whenever its acceptance by buyers leads to a probable violation of seller's resource constraints. This renders vacuous threats to equilibrium that Rothschild and Stiglitz view as leading to extreme market failure.

Pricing and Hedging Oil Futures: A Two-Regime Approach

We develop and empirically test a continuous-time equilibrium model for the pricing of oil futures. Our model provides a link between no-arbitrage and expectations-oriented models, and highlights the role of inventories in identifying different pricing regimes. We compare the hedging performance of our model with five other one- and two-factor pricing models. Our hedging problem relates to Metallgesellschaft's strategy to hedge long-term forward commitments with short-term futures. In the base case, the downside risk distribution of our inventory-based model stochastically dominates those of the other models. We test the stability of our results by varying the empirical design.

Instructional Case: Great Lakes Forest Products

The focus of this case is a Canadian company with mostly US dollar sales and Canadian dollar costs operating in a flexible exchange rate environment. It is also undergoing a major expansion of its facilities. The operating and foreign exchange risk induce the firm to sell forward almost US$1 billion in order to hedge anticipated US revenues. The company also engages in extensive US dollar debt financing. Subsequently, Great Lakes' revenues are affected by both price effects and very large volume effects that effectively both reverse its exposure and call into question whether or not there would be sufficient foreign revenues to fulfil the contracted forward sales of foreign currency. The pedagogic value of the case is to lead the student through the critical issues involved in ‘hedge’ accounting. The company actually deferred all gains and losses on its medium-term forward contracts, even though its revenue decline called into question its ability to meet its forward commitments from actual sales. The stu...

Taxes and the hedging of forward commitments

Journal of Futures MarketsVolume 6, Issue 2 p. 207-222 Article Taxes and the hedging of forward commitments Robert L. McDonald, Robert L. McDonald Assistant Professor of Finance at the J. L. Kellogg Graduate School of Management at Northwestern UniversitySearch for more papers by this author Robert L. McDonald, Robert L. McDonald Assistant Professor of Finance at the J. L. Kellogg Graduate School of Management at Northwestern UniversitySearch for more papers by this author First published: Summer 1986 https://doi.org/10.1002/fut.3990060204AboutPDF ToolsRequest permissionExport citationAdd to favoritesTrack citation ShareShare Give accessShare full text accessShare full-text accessPlease review our Terms and Conditions of Use and check box below to share full-text version of article.I have read and accept the Wiley Online Library Terms and Conditions of UseShareable LinkUse the link below to share a full-text version of this article with your friends and colleagues. Learn more.Copy URL Volume6, Issue2Summer 1986Pages 207-222 RelatedInformation

An Econometric Approach to the FNMA Free Market System Auction

Through the FMS auctions, FNMA issues optional forward commitments (four months) for the purchase of single-family mortgage loans from originating lenders. Basically, lenders offer to sell mortgages to FNMA at specified yields. FNMA then evaluates these offers, determines the amount of mortgages it will purchase (i.e., the yields it will accept), and then issues forward commitments to the successful bidders.