Futures markets and the theory of the firm under price uncertainty*

Feder, G., Just, R. E., & Schmitz, A. (1980). Futures markets and the theory of the firm under price uncertainty. The Quarterly Journal of Economics, 94(2), 317-328.*******

==Notes by yinung==

related to Sandmo (1971);


The  theory  of  the  firm  under  price  uncertainty  has  been  the subject  of  a  considerable  number  of  studies.  While  the  papers  by Sandmo  [1971], Leland  [1972], Batra  and Ullah  [1974], and  others  have undoubtedly advanced the understanding of the decision making of firms under uncertainty,  the theory is not complete unless forward  delivery  contracts  are  considered.  Such  contracts,  referred  to  as  “futures," are playing an increasingly  important  role in a number of  commodity  markets.


This paper examines the behavior of a competitive firm under price uncertainty where a futures market exists for the commodity produced by the firm. Working with the Sandmo approach, we found that production decisions depend only on the futures market price and input costs; the subjective distribution of future spot price affects only the firm’s involvement in futures trading. Conditions are then determined under which a firm will either hedge, speculate by buying futures contracts, or speculate by selling futures contracts. The results indicate that an important social benefit derived from the existence of a futures market is to eliminate output fluctuations due to variation in producers’ subjective distributions of future spot price.



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