Fixed Price Versus Spot Price Contracts: A Study in Risk Allocation

Abstract

This paper is concerned with the risk-allocation effects of alternative types of contracts used to set the price of a good to be delivered in the future.Under a fixed price contract, the price is specified in advance.Under a spot price contract, the price is the price prevailing in the spot market at the time of delivery.These contract forms are examined in the context of a market in which sellers have uncertain production costs and buyers have uncertain valuations.The paper derives and interprets a general condition determining which contract form would be preferred when the seller and/or the buyer is risk averse.In addition, an example is provided in which a spot price contract with a floor price is superior both to a "pure" spot price contract and a fixed price contract.

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