Strategic Default in the International Coffee Market

98 Pages Posted: 26 Sep 2017

See all articles by Arthur Blouin

Arthur Blouin

University of Warwick

Rocco Macchiavello

University of Oxford - Nuffield College of Medicine; Centre for Economic Policy Research (CEPR)

Date Written: September 2017

Abstract

This paper studies strategic default on coffee pre-financing agreements. In these common arrangements, mills finance coffee production through loans backed by forward-sales contracts with foreign buyers. We model how strategic default introduces a trade-off between insurance and counterparty risk: relative to indexed contracts, fixed-price contracts insure against price swings but create incentives to default when market conditions change. To test for strategic default, we construct contract-specific measures of unanticipated changes in market conditions by comparing spot prices at maturity with the relevant futures prices at the contracting date. Unanticipated rises in market prices increase defaults on fixed price contracts but not on price-indexed ones. We isolate strategic default by focusing on unanticipated rises at the time of delivery after production decisions are sunk. Estimates suggest that roughly half of the observed defaults are strategic. Strategic defaults are more likely in less valuable relationships which, in turn, tend to sign price-indexed contracts to limit strategic default. A model calibration suggests that strategic default causes 15.8\% average losses in output, significant dispersion in the marginal product of capital and sizeable negative externalities on supplying farmers.

Keywords: Contractual Forms, Counterparty Risk, Strategic Default

JEL Classification: D22, G32, L14, O16

Suggested Citation

Blouin, Arthur and Macchiavello, Rocco, Strategic Default in the International Coffee Market (September 2017). CEPR Discussion Paper No. DP12307, Available at SSRN: https://ssrn.com/abstract=3042617

Arthur Blouin (Contact Author)

University of Warwick ( email )

Gibbet Hill Rd.
Coventry, West Midlands CV4 8UW
United Kingdom

Rocco Macchiavello

University of Oxford - Nuffield College of Medicine ( email )

New Road
Oxford, OX1 1NF
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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