nep-cta 2025-11-10 papers

on Contract Theory and Applications

Issue of 2025–11–10
two papers chosen by
Guillem Roig, University of Melbourne

Designing Contracts for the Energy Transition By Natalia Fabra; Gerard Llobet
The Costs of Counterparty Risk in Long-Term Contracts By Natalia Fabra; Gerard Llobet

Designing Contracts for the Energy Transition

By:	Natalia Fabra (CEMFI, Centro de Estudios Monetarios y Financieros); Gerard Llobet (CEMFI, Centro de Estudios Monetarios y Financieros)
Abstract:	This paper examines the limitations of spot markets in providing adequate investment incentives to support zero-carbon investments in electricity markets. In contrast, properly designed long-term contracts have the potential to mitigate price volatility and facilitate the funding of the investments. A theoretical model is developed to analyze contract design under conditions of moral hazard and adverse selection, emphasizing the trade-offs that arise when exposing firms to price and quantity risk. The findings inform optimal contract design for nuclear and renewable energy projects, offering policy recommendations to enhance investment incentives while minimizing productive inefficiencies and excessive rents.
Keywords:	Contract design, adverse selection, moral hazard, risk aversion, renewable energies, nuclear power plants.
JEL:	L13 L94
Date:	2025–10
URL:	https://d.repec.org/n?u=RePEc:cmf:wpaper:wp2025_2521

The Costs of Counterparty Risk in Long-Term Contracts

By:	Natalia Fabra (CEMFI, Centro de Estudios Monetarios y Financieros); Gerard Llobet (CEMFI, Centro de Estudios Monetarios y Financieros)
Abstract:	This paper investigates the implications of counterparty risk - stemming from potential defaults or renegotiations by buyers - on long-term contract markets. It develops a theoretical model highlighting how opportunistic buyer behavior leads to higher contract prices and underinvestment, potentially leading to the collapse of the contract market. The paper also evaluates public-policy interventions, including public subsidies, financial guarantees, regulator-backed contracts, and collateral requirements. While these measures can reduce price-related inefficiencies and promote investment, they involve trade-offs such as moral hazard or the reliance on costly public funds. These findings are particularly relevant for sectors with capital-intensive, long-lived assets exposed to price volatility, especially electricity markets, where underinvestment in renewable energy could delay the energy transition and hinder carbon-abatement goals. Simulations using data for the Spanish electricity market are used to quantify the theoretical predictions of the model.
Keywords:	Imperfect contract enforcement, counterparty risk, renewable investments, bilateral contracts, vertical integration, dynamic incentives.
JEL:	L13 L94
Date:	2025–10
URL:	https://d.repec.org/n?u=RePEc:cmf:wpaper:wp2025_2523

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