The Simultaneous Determination of Spot and Futures Pries in a Simple Model with Production Risk

Abstract

This paper deals with properties of a rational expectations equilibrium when there is futures trading. A simple two-good model is analyzed, where one of the goods is produced subject to production risk. Although the futures market provides insurance against price risk to producers, it is income risk that concerns them. Whether they hedge in equilibrium is shown to depend on the price and income elasticity of demand for their output as well as on the degree to which consumers—the other party in the futures transaction-—are risk-averse.