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Strategic Default in the International Coffee Market

Arthur Blouin and Rocco Macchiavello
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Arthur Blouin: University of Toronto
Rocco Macchiavello: London School of Economics

CAGE Online Working Paper Series from Competitive Advantage in the Global Economy (CAGE)

Abstract: This paper studies strategic default on coffee pre-financing agreements. In these common arrangements, mills finance coffee production through loans backed by forward-sales contracts with foreign buyers. We model how strategic default introduces a trade-off between insurance and counterparty risk: relative to indexed contracts, fixed-price contracts insure against price swings but create incentives to default when market conditions change. To test for strategic default, we construct contract-specific measures of unanticipated changes in market conditions by comparing spot prices at maturity with the relevant futures prices at the contracting date. Unanticipated rises in market prices increase defaults on fixed price contracts but not on priceindexed ones. We isolate strategic default by focusing on unanticipated rises at the time of delivery after production decisions are sunk. Estimates suggest that roughly half of the observed defaults are strategic. Strategic defaults are more likely in less valuable relationships which, in turn, tend to sign price-indexed contracts to limit strategic default. A model calibration suggests that strategic default causes 15.8% average losses in output, significant dispersion in the marginal product of capital and sizeable negative externalities on supplying farmers.

Keywords: Strategic Default; Contractual Forms; Counterparty Risk. JEL Classification: D22; L14; G32; O16. (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-agr and nep-cta
Date: 2018
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Persistent link: https://EconPapers.repec.org/RePEc:cge:wacage:369

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