Effects of Futures Trading on the Spot Market Bid–Ask Spread

We analyse how the presence of a futures market gives risk‐averse dealers in the spot asset opportunities for arbitrage that reduce the spot market bid–ask spread through reducing the dealers’ risk exposure. In particular if the spot and futures risks are perfectly correlated then the spot bid–ask spread is zero in equilibrium and all spot dealer risk can be diversified away. We also analyse the equilibrium futures price in this two‐market scenario.