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The Informational Role of Spot Prices and Inventories

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  • Smith, James L.

    () (Resources for the Future)

  • Thompson, Rex

Abstract

We examine the role that spot markets and physical inventories play in revealing to uninformed traders the expectations of informed traders. Although many papers investigate potential mechanisms by which futures markets may disseminate such information, the role of spot markets has not been examined in comparable detail. Because the incentive for speculative trading in futures contracts stems from the failure of spot markets to eliminate differences in beliefs regarding future market conditions, the scope for speculative trading in the futures market is therefore determined, but also limited, by the extent to which spot market transactions disseminate private information. Using a rational expectations approach, we show that equilibrium differences in beliefs are determined by specific characteristics of the underlying commodity, including storage costs, the amplitude of unexpected demand and supply shocks, the accuracy of information acquired by informed investors, the numbers of informed and uninformed investors, and the elasticity of demand and supply.

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Bibliographic Info

Paper provided by Resources For the Future in its series Discussion Papers with number dp-12-45.

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Date of creation: 27 Sep 2012
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Handle: RePEc:rff:dpaper:dp-12-45

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Keywords: futures trading; speculation; inventories; private information;

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  1. Tirole, Jean, 1982. "On the Possibility of Speculation under Rational Expectations," Econometrica, Econometric Society, vol. 50(5), pages 1163-81, September.
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