How Do Futures Markets Develop?

It would seem that the answer to the question posed in the title is simple. Futures markets develop because there is a need for the risk-shifting and price discovery functions they provide in the marketplace. As far as it goes, this statement is true. However, it is not very helpful in understanding how the actual development of futures markets evolved. I don’t know any better and more succinct statement on the matter than this paragraph from “Economics of Futures Trading” by Tom Hieronymus:

“Futures markets were not invented and imposed on the existing marketing system but evolved out of the need for the performance of marketing functions that the then existing marketing system was not doing adequately. They did not start as a separate or alternative way of doing business but as an extension and refinement of existing practices. They have been in a continuous state of change, development, and refinement throughout their history. The focus of futures trading has changed as the commercial setting has changed. The commercial setting has changed rapidly in recent decades and will likely change at a greater speed in the decades ahead.” (p. 71)

I have seen so many efforts over the years to develop futures markets that have this logic exactly backwards. The idea is that starting a futures market will somehow spur the development of underlying cash markets. Some examples include carbon futures, water futures, futures in less developed countries, and on and on. This never works because successful futures markets develop out of existing commercial practices, not vice versa. A lot of money could have been saved over the decades by simply reading what the master, Tom Hieronymus, had to say on this matter.

This is just one example of the timeless market wisdom you will find in “Economics of Futures Trading.” As I noted last week, a new hardcover edition is is now available from Ingram Spark for only $21.99 plus shipping at this link. If you prefer to purchase through Amazon, the hardcover edition is available for the still quite reasonable price of $29.99 here. Complete details about the book and the availability of the paperback and ebook versions can be found on this page here at my website. 

 

Browse other posts by category: