Pulp Friction: The Value of Quantity Contracts in Decentralized Markets

47 Pages Posted: 10 Sep 2021

See all articles by Juha Tolvanen

Juha Tolvanen

Department of Economics

Olivier Darmouni

Columbia University - Columbia Business School

Simon Essig Aberg

affiliation not provided to SSRN

Date Written: September 4, 2021

Abstract

Firms in decentralized markets often trade using quantity contracts, agreements that specify quantity in advance of trade. We show that firms use quantity contracts to reduce the costs of trading frictions. Specifically, quantity contracts are valuable for two reasons. First, they increase trade between high surplus trading partners because they lock in trade prior to the point of sale. Second, they provide quantity insurance -- we show that buyers and sellers are endogenously risk averse with respect to quantity. However, quantity contracts are costly due to their inflexibility to market conditions. Using proprietary invoice data from a large seller, we estimate a model of quantity contracts in the pulp and paper industry. We find that the median value of a quantity contract is 10% of net price. The median value would be 25% lower without quantity insurance and 84% higher without the cost of inflexibility. As trading frictions diminish, the seller uses fewer quantity contracts and profits increase.

Keywords: Decentralized markets, contracts, trading frictions

JEL Classification: L14, L22, D23, L73

Suggested Citation

Tolvanen, Juha and Darmouni, Olivier and Essig Aberg, Simon, Pulp Friction: The Value of Quantity Contracts in Decentralized Markets (September 4, 2021). Available at SSRN: https://ssrn.com/abstract=3919592 or http://dx.doi.org/10.2139/ssrn.3919592

Juha Tolvanen (Contact Author)

Department of Economics ( email )

Vienna, A-1210
Austria

Olivier Darmouni

Columbia University - Columbia Business School ( email )

3022 Broadway
New York, NY 10027
United States

Simon Essig Aberg

affiliation not provided to SSRN

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