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Looking for Spot in the Presence of Futures-super-

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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. Copyright (c) International Review of Finance Ltd. 2003.

Suggested Citation

  • Krishna Ramaswamy & Patrick Waldron, 2003. "Looking for Spot in the Presence of Futures-super-," International Review of Finance, International Review of Finance Ltd., vol. 4(3-4), pages 101-123.
  • Handle: RePEc:bla:irvfin:v:4:y:2003:i:3-4:p:101-123
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