TRADING CASE IN2

Private information in spot and forward stock-index markets

LEARNING
OBJECTIVE		Understand how private information is incorporated into spot and forward stock-index prices and how market prices can aggregate information held by different traders.
KEY CONCEPTSPrivate information  |  Forecast error  |  Information aggregation  |  Spot-forward parity  |  Price discovery  |  Market making and taking

HOW THE CASE WORKS

IN2 uses the same three markets and settlement rules as IN1. The difference is that every trader receives private analyst forecasts for Index A and Index B during the trading day. Forecasts differ across traders and become more precise over time.

MARKETS

MarketInstrumentYear-end value
Index ASpot basket replicating Index ARealized Index A
Index BSpot basket replicating Index BRealized Index B
Index B forwardOne-year forward on Index BLong: ST - K

INDEX VALUES

Each index independently realizes 7,900 or 12,100, with equal probability. Index A and Index B have the same distribution, but their realizations are independent.

FORECAST MESSAGES

Click an index security once to display its information. A message such as Forecast Time: 0 - Index A forecast = 11,076.705 is that trader's unbiased estimate of the year-end Index A value, available at the start of trading.

PRIVATE INFORMATION

Each forecast equals the true index value plus or minus an error. The expected error is zero, but its realized sign and size vary. Trader types receive different forecasts, so the market collectively has better information than any single trader.

FORECAST PRECISION

Forecast error = (x - 0.5) x y(time), where x is random between 0 and 1. Across ten updates, y(time) declines from 5,000 to 500 in steps of 500. The maximum error therefore narrows from +/-2,500 to +/-250.

TRADING RULES

  • Enter bids and asks for quantities up to 10,000 units.
  • Buy at the prevailing ask or sell to the prevailing bid, up to displayed quantity.
  • Short sales and money-market borrowing or lending are permitted.
  • Multiple independent trials are conducted; results accumulate.

PRICING CONNECTION

Use private forecasts to value the spot indices, but also learn from market prices and order flow. For Index B, compare the spot price with the one-year forward using F0,T = S0(1 + r), where r = 5%.

AFTER TRADING CLOSES

  • Apply 5% interest to closing cash.
  • Mark Index A and Index B positions to their independent realized values.
  • Cash-settle the Index B forward.
  • Convert all positions to end-of-year cash.
YOUR TASKTrade the spot and forward markets by combining your private forecasts with public market signals, spot-forward parity, financing, and settlement mechanics. Decide when to rely on your own information and when market prices reveal more.

PERFORMANCE: Trading bonus per trial = 0.0001 x end-of-year market cash. Positive wealth adds bonus cash; negative wealth subtracts it. Results accumulate across independent trials.

FINANCIAL TRADING SYSTEM  |  STUDENT + INSTRUCTOR QUICK GUIDECASE IN2  |  1 OF 2

TRADING CASE IN2

Suggested questions for the classroom results discussion

PREPARATIONComplete these questions before the classroom session that discusses market results. Use specific forecasts, prices, quotes, trades, quantities, or moments from your own experience.
SUGGESTED QUESTIONS - COMPLETE BEFORE THE CLASSROOM RESULTS DISCUSSION
1 INITIAL FORECASTWhat were your first forecasts for Index A and Index B? How did they affect your initial bids, asks, or trades?
2 UPDATINGChoose a later forecast with a smaller possible error. How did it change your valuation or position?
3 MARKET SIGNALIdentify a market price or order-flow signal that conflicted with your private forecast. Which signal did you trust, and why?
4 AGGREGATIONGive one example suggesting that the market price combined information from many traders more effectively than your forecast alone.
5 INDEX COMPARISONDid information or prices in Index A influence your view of Index B? Explain why that comparison was informative or misleading given independent realizations.
6 SPOT-FORWARDHow did your private Index B forecast affect your valuation of both Index B spot and its forward contract?
7 RISKHow did you manage the exposure created by private-information trades across spot, forward, and cash positions?
8 NEXT TRIALWhat would you change about how you used private forecasts, market prices, quoting, position size, or execution in another trial?

Bring your responses to class. The purpose is to compare your initial reasoning with the information revealed by market prices and the strategies discussed during the results session.