Natural Selection and Market Efficiency in a Futures Market with Random Shocks

Journal of Futures Markets, Vol. 21, No. 6, pp. 489-516, 2001

34 Pages Posted: 14 May 2009 Last revised: 26 May 2009

Abstract

Even when participants know very little about their environment, the market, itself, by serving as a selection process of information, promotes an efficient aggregate outcome. To emphasize the role of the market and the importance of natural selection, rather than the strategic actions of participants, an evolutionary model of a commodity futures market is presented, in which there is a continual inflow of unsophisticated traders with predetermined distributions of prediction errors with respect to the fundamental value of the spot price. The market acts as a selection process by constantly shifting wealth from traders with less accurate information to those with more accurate information. Consequently, with probability one, if the volatility of the underlying spot market is sufficiently small, then the proportion of time, that the futures price is sufficiently close to the fundamental value, converges to one. Furthermore, the width of the interval containing the fundamental value, where the futures price eventually lies, increases as the volatility of the underlying spot market increases.

Keywords: Natural selection, Informational Efficiency, Market Behavior, Commodity Futures Market

JEL Classification: G14, G10, C73

Suggested Citation

Luo, Guo Ying, Natural Selection and Market Efficiency in a Futures Market with Random Shocks. Journal of Futures Markets, Vol. 21, No. 6, pp. 489-516, 2001. Available at SSRN: https://ssrn.com/abstract=1404153

Guo Ying Luo (Contact Author)

McMaster University

1280 Main Street West
Hamilton, Ontario L8S 4M4
Canada
905 525 9140 ext. 23983 (Phone)

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