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Looking for Spot in the Presence of Futures

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  • Krishna Ramaswamy
  • Patrick Waldron

Abstract

This paper deals with a novel problem of price search in a world where futures markets play an important role. In the absence of the futures market, customers are unable to tell whether a high spot quote reflects a fundamental change in market conditions or whether they have run into a high‐pricing dealer. The optimal strategy of a customer carrying out a costly search among dealers for the best spot price (while also participating in a futures market) is shown to have a reservation price property, where the reservation price is a function of the current futures price. In equilibrium, dealers randomize their price quotes in a way that is consistent with searchers' expectations, yielding a self‐fulfilling expectations equilibrium. This solution is consistent with optimal dealer behavior.

Suggested Citation

  • Krishna Ramaswamy & Patrick Waldron, 2003. "Looking for Spot in the Presence of Futures," International Review of Finance, International Review of Finance Ltd., vol. 4(3‐4), pages 101-123, September.
    • Handle: RePEc:bla:irvfin:v:4:y:2003:i:3-4:p:101-123
    DOI: 10.1111/j.1468-2443.2005.00048.x
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    JEL classification:

    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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