Competition with forward contracts: a laboratory analysis motivated by electricity market design. Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC

We use experiments to study the efficiency effects of adding the possibility of forward contracting to a spot market. We focus on the strategic implications of a forward market and consider both quantity and supply function competition. In both cases we compare the effect of adding a contract market to the introduction of an additional competitor. We find that, as theory suggests, for both types of competition the introduction of a forward market significantly lowers prices. The combination of supply function competition with a forward market leads to high efficiency levels. In the worldwide process of regulatory reform in the electricity industry, the mitigation of market power is one of the basic problems regulators have to deal with. One way that can potentially be used to address this problem is to allow for forward contracts between producers and traders. In this article we use experiments to study the effects of forward contracting in an imperfectly competitive market. The original rationale for forward markets is related to the hedging of risk; for a recent study, see Hortaçsu and Puller (2004). An influential study by Allaz and Vila (1993) added a second rationale. They show that the presence of a forward market changes producers strategic incentives in a way that, in equilibrium, enhances com