Competitive Forward and Spot Trading Under Yield Uncertainty

Agricultural producers face significant yield uncertainty which can cause unpredictable outputs and volatile prices of agricultural commodities. They usually trade those commodities not only in a spot market but also in a forward market to manage price uncertainty. In this section, we develop a game theoretical model to study competing firms’ production decisions in the planting season and trading behaviors in the forward and spot markets. The model also allows us to examine the impact of yield uncertainty and the existence of the forward market on the equilibrium outcomes. We find some counterintuitive results that an increase in yield risk may increase firms’ equilibrium profits and decrease the spot price volatility. A comparison between the models with and without a forward market reveals that the firms’ profits decrease but the spot price volatility increases when there is a forward market. Finally we show that a higher yield risk mitigates the role of the forward market but a higher yield correlation enhances it.