Looking for Spot in the Presence of Futures*

Krishna Ramaswamy () and Patrick Waldron

International Review of Finance, 2003, vol. 4, issue 3‐4, 101-123

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.

Date: 2003
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https://doi.org/10.1111/j.1468-2443.2005.00048.x

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