As the delivery period for a futures contract is approached, the futures price converges to the spot price for the underlying asset. When the delivery period is reached, the futures price nearly equals the spot price as traders exploit the difference between the future and spot prices. This activity increases as the expiration date of the future approaches.
 

The relatively small size of the currency futures market compared to the (OTC) spot market suggests that the futures market might not play an important role in price discovery. According to the 2004 BIS Triennial survey, average daily volume in exchange-traded currency products totaled 23 billion compared to 1,345 billion in over thecounter products.

However, the foreign currency futures market’s role might be larger than its relative size would indicate. The wide range of futures market participants (from hedge funds to corporate hedgers), centralized location, anonymity of counterparty identity, and high level of price transparency suggest that futures trading could potentially aggregate a rich source of private information.

Whether the spot or the futures market is the center of price discovery in commoditymarkets has for a long time been discussed in the literature. Stein (1961) showed that futures and spot prices for a given commodity are determined simultaneously. Garbade and Silver (1983) in their empirical application concludes that “about 75 percent of new information is incorporated first in the future prices.”
 

Why might a trading venue with lower market share have a disproportionate influence in price determination? The predominant answer given in the literature is because an alternative trading venue attracts a large share of informed traders. Specifically, informed traders may prefer a satellite market if it offers greater anonymity of trader identity or higher speed of transaction execution. Evidence along these lines is presented in Huang (2002), Barclay, Hendershott and McCormick (2003), Hasbrouck (2003), and Kurov and Lasser (2004).

While not able to offer direct evidence on the speed of execution in foreign currency futures versus spot markets, the institutional structure of the currency futures market preserves anonymity of the dealer’s identity with the trade counterparty (when a dealer executes through a broker), while interdealer spot market does not. In the foreign exchange futures market, the counterparty to each side of a trade is the futures clearinghouse so trader identity is not revealed, even at settlement. By contrast, in the foreign exchange spot market, a dealer’s identity is disclosed
when a quote is requested or given (direct trading) or when the trade is complete (indirect trading).

A second reason that a satellite market might be important in the price discovery process is a higher level of price transparency than the primary market. As noted inMadhavan (2000), “[Transparency] affects the informativeness of order flow and hence the process of price discovery. Greater transparency is generally associated with more informative prices (p. 241).” However, informed traders may prefer to execute on a less transparent primary exchange in order to extract greater profits from their private information as discussed in Bloomfield and O'Hara (1999) and Biais, Glosten and Spatt(2005).
 

In the context of foreign exchange, Rime (2003) points out the relatively low level of price transparency in interdealer direct trading (which is the market segment analyzed in Evans and Lyons (2002b)) prior to the emergence of electronic brokerage in the late 90’s. The growth in trading on electronic brokerage systems, primarily Reuters Dealing 2000 and EBS, led to a dramatic increase in spot market transparency, since these systems report spot transactions prices in real time to participating dealers and also offer data feeds to other customers.