The Costs of Counterparty Risk in Long-Term Contracts

Natalia Fabra () and Gerard Llobet
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Natalia Fabra: CEMFI, Centro de Estudios Monetarios y Financieros, https://www.cemfi.es/

Working Papers from CEMFI

Abstract: This paper investigates the implications of counterparty risk - stemming from potential defaults or renegotiations by buyers - on long-term contract markets. It develops a theoretical model highlighting how opportunistic buyer behavior leads to higher contract prices and underinvestment, potentially leading to the collapse of the contract market. The paper also evaluates public-policy interventions, including public subsidies, financial guarantees, regulator-backed contracts, and collateral requirements. While these measures can reduce price-related inefficiencies and promote investment, they involve trade-offs such as moral hazard or the reliance on costly public funds. These findings are particularly relevant for sectors with capital-intensive, long-lived assets exposed to price volatility, especially electricity markets, where underinvestment in renewable energy could delay the energy transition and hinder carbon-abatement goals. Simulations using data for the Spanish electricity market are used to quantify the theoretical predictions of the model.

Keywords: Imperfect contract enforcement; counterparty risk; renewable investments; bilateral contracts; vertical integration; dynamic incentives. (search for similar items in EconPapers)
JEL-codes: L13 L94 (search for similar items in EconPapers)
Date: 2025-10
New Economics Papers: this item is included in nep-com, nep-cta, nep-ene, nep-reg and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:cmf:wpaper:wp2025_2523

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