This article provides a simple equilibrium model of a futures market. Since the futures market is a zero sum game, some firms will, in equilibrium, end up being 'speculators' who bet against 'hedgers'. We show it is firms that have high initial capital and/or poor production opportunities that are the most likely candidates to bet against the hedgers. In equilibrium, these groups earn a premium in order to provide this insurance so that speculating increases value. We also provide some results that imply an inverted U shaped relationship between trading volume and the level of futures prices. Empirical evidence from the S&P futures contract provides strong empirical support for this theoretical result.
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Document Type: Research Article
College of Business Administration, University of Rhode Island, Kingston, RI 02881
Department of Economics and Finance, School of Business, Clayton State University, Morrow, GA 30260, USA
J. Mack Robinson College of Business, Georgia State University, Atlanta, GA 30303-3083
Publication date: 2009-12-01
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