Pulp Friction: The Value of Quantity Contracts in Decentralized Markets

Abstract

Firms in decentralized markets often trade using quantity contracts, agreements that specify quantity prior to the point of sale. Quantity contracts are valuable because they reduce the costs of trading frictions. Quantity contracts insure against the event that trading frictions prevent a buyer and seller from matching in the spot market. However, quantity contracts eliminate the option to reallocate production after market conditions realize. Using proprietary invoice data, we estimate a model of quantity contracts in the pulp and paper industry. The median value of a quantity contract is 12% of price. The lost option value is 0.7% of price.

Keywords: Decentralized markets, contracts, trading frictions

JEL Classification: L14, L22, D23, L73