Derivatives and Default Risk

Sebastian Scholz

Discussion Papers in Economics from University of Munich, Department of Economics

Abstract: Upstream producers that possess market power, sell forwards with a lengthy duration to regional electricity companies (REC). As part of the liberalization of the electricity market, RECs have been privatized and exposed to a possible bankruptcy threat if spot prices have fallen below their expected value. The downstream firms’ expected profit is larger, when it is less likely to be bailed out, the effect on upstream profits is ambiguous while consumers loose. Options are less welfare increasing than forwards, but the difference is minimal. In the presence of bankruptcy, options are the preferred welfare maximizing market instrument.

Keywords: Forwards; Options; Default Risk; Market Efficiency (search for similar items in EconPapers)
JEL-codes: D43 G33 G34 G35 (search for similar items in EconPapers)
Date: 2010-01
New Economics Papers: this item is included in nep-ene and nep-reg
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