Working Paper: NBER ID: w1817
Authors: A. Mitchell Polinsky
Abstract: Thi spaper is concerned with the risk-allocation effects of alternative types of contracts used to set the price of a good tobe delivered in the future. Under a fixed price contract, the price is specified in advance. Under a spot price contract, the price is the price prevailing in the spot market at the time of delivery.These contract forms are examined in the context of a market in which sellers have uncertain production costs and buyers have uncertain valuations. The paper derives and interprets a general condition determining which contract form would be preferred when the seller and/or the buyer is risk averse. In addition, an example is provided in which a spot price contract with a floor price is superior both to a "pure" spot price contract and a fixed price contract.
Keywords: risk allocation; contracts; fixed price; spot price
JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Spot price contract (G13) | Insures seller against production cost uncertainty (G13) |
| Fixed price contract (D41) | Insures buyer against valuation uncertainty (G52) |
| Seller's risk aversion > Buyer's risk aversion (D81) | Spot price contract preferred (G13) |
| High production costs (D24) | High spot price (G13) |
| Both parties risk averse (D81) | Hybrid contract optimal (D86) |
| Neither contract fully protects seller against supply-side and demand-side risks (L14) | Complicates contract choice (D86) |
| Variances of profits and risk aversion coefficients (D81) | Contract preference (K12) |