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European Review of Agricultural Economics 2007 34(2):257-282; doi:10.1093/erae/jbm019
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© Oxford University Press and Foundation for the European Review of Agricultural Economics 2007; all rights reserved. For permissions, please email journals.permissions@oxfordjournals.org

On the co-existence of spot and contract markets: the delivery requirement as contract externality

George W. J. Hendrikse

RSM Erasmus University, Rotterdam, The Netherlands

Corresponding author: George W.J. Hendrikse, RSM Erasmus University, Office T8-56, P.O. Box 1738, 3000 DR Rotterdam, The Netherlands. E-mail: ghendrikse{at}rsm.nl

Received June 2006; Revision received May 2007. A contract between an upstream and a downstream party consists of a contract price and a delivery requirement. Contract formation entails an externality. It changes the probability distribution of the spot market price by removing high reservation price buyers and various sellers from the spot market. The first effect decreases the expected spot market price when the number of contracts is small, whereas the decrease in the number of sellers and additional residual contract demand increase the expected spot market price beyond a certain number of contracts. It implies an endogenous upper bound on the number of contracts. Contract prices are positively related to the number of contracts. Finally, additional contract formation reduces the variance of the spot market price when the number of contracts is sufficiently large.

Keywords: spot market, contract externality, co-existence, delivery requirement

JEL classification: L14, Q11, Q13


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