Forward Commodity Trading with Private Information

AbstractFirms 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.We consider the use of forward contracts to reduce risk for firms operating in a spot market. Firms have private information on the distribution of prices in the spot market. We discuss different ways in which firms may agree on a bilateral forward contract: either through direct negotiation or through a broker. We introduce a form of supply-function equilibrium in which two firms each offer a supply function, and the clearing price and quantity for the forward contracts are determined from the intersection. In this context, a firm can use the offer of the other player to augment its own information about the future price.The online appendices are available at https://doi.org/10.1287/opre.2018.1777.