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Natural Selection, Random Shocks, and Market Efficiency in a Futures Market

In: Evolutionary Foundations of Equilibria in Irrational Markets

Author

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  • Guo Ying Luo

    (McMaster University)

Abstract

This chapter adds a random shock to the futures market to see if an informationally efficient equilibrium would still occur. In this chapter, the prices are modeled as continuous variables and traders can buy or sell with a single submission of their quotes. The conclusion is that,with probability one, if the volatility of the underlying spot market is sufficiently small, then the proportion of time that the futures price is sufficiently close to the fundamental value converges to one. However, the interval containing the fundamental value, where the futures price eventually lies, is influenced by the underlying volatility generated from the spot market. In other words, the accuracy of the information for which the market can eventually select, depends on the volatility generated from the random shock in the spot market. The more volatile the spot market, the more noisy is the information that gets selected for. As a result, the futures market moves further away from informational efficiency. Numerical examples are used to illustrate the cause of the convergence and how the wealth is redistributed among traders.

Suggested Citation

  • Guo Ying Luo, 2012. "Natural Selection, Random Shocks, and Market Efficiency in a Futures Market," Studies in Economic Theory, in: Evolutionary Foundations of Equilibria in Irrational Markets, chapter 0, pages 89-112, Springer.
    • Handle: RePEc:spr:steccp:978-1-4614-0712-6_5
    DOI: 10.1007/978-1-4614-0712-6_5
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