Contract settlement specification and price discovery: Empirical evidence in Australia individual share futures market

This study applies Geweke [J. Am. Stat. Assoc. 76 (1982) 304] measures of information flow and dependence between Australian individual share futures (ISF) contract and its underlying stock market to investigate whether the price discovery function of futures price has been enhanced after the switch of futures contracts from cash settlement to physical delivery. It is found that the spot market leads the futures market as the futures trading volume is rather small. Further tests suggest that the switch from cash settlement to physical delivery in the ISF contracts has reinforced the information flow from the spot market to the futures market.     

Commodity futures contracts: Furnishing an elastic currency in the nineteenth century

In this paper, I show that nineteenth century US interest rates are relatively more volatile before 1874 and I propose, and demonstrate how, commodity futures trading is the likely principal proximate explanation for this change in behavior. Borrowing from Turnovsky [Econometrica 51 (1983) 1363], I model the optimizing behaviors of risk averse producers and risk neutral speculators in the absence and presence of futures contracts and I show that, so long as one party to a futures contract was risk averse, futures markets would have quelled interest rate volatility caused by variations in planting and harvesting conditions.     

Effects of electronic trading on the Hang Seng Index futures market

This investigation of the switch from open-outcry trading to electronic trading on the Hang Seng Index (HSI) futures contract reveals that the bid–ask spread narrows and the futures price plays more of a role in information transmission. Factors, such as anonymity in trading and fast order execution in electronic trading, attract informed traders to the futures market, enhancing the information flow. Our results provide support for the worldwide trend of transforming open-outcry markets into electronic trading platforms.     

Crude Oil Futures as an Indicator of Market Changes: A Graphical Analysis

This study investigates the changing relationship between price and volume traded of short- and long-maturity NYMEX light sweet crude oil futures contracts and major changes in the physical crude oil market during the last decade. Monthly series for the #1-month to 84-month out maturity contracts are generated from daily price and volume data for NYMEX West Texas Intermediate (WTI) futures contracts for the period from January 2000 to the middle of 2009. 3-D graphical analysis of the futures prices, contract volumes, maturity dates, and time is used to demonstrate the changing trading volume pattern and evolution of the shape of futures price term structure across various contract maturities in different market regimes. The study observes the impacts of both May 2004, when excess production capacity reached nearly zero, and September 2006, when electronic trading was implemented on the NYMEX WTI futures markets. This analysis will be used to determine if futures contract information can provide an early indication of market regime shifts and improve short-run crude oil spot price forecast models.     

Volatility,maturity and volume in the Indian metals futures

This study examines the validity of Samuelson hypothesis and the mixture of distribution hypothesis to uncover time-to-maturity and trading volume as the sources of volatility in gold and copper futures. Exponential generalized autoregressive conditional heteroskedasticity model is used for empirical analysis. Leverage effect is found in copper futures but not in gold futures. We find evidence of the Samuelson maturity effect even after controlling for the trading volume. The mixture of distribution hypothesis is strongly supported. Hence trading volume, a proxy for information arrival, is one of the important determinants of volatility, and it dominates time-to-maturity. The results have implications for setting the desired level of margin requirements in futures contracts, designing effective hedging strategy and strengthening the risk management practices.     

Baltic freight futures: Random walk or seasonally predictable?

Ocean freight futures, the only futures contract on a service, began trading on the BIFFEX Exchange in 1985. The Chow and Denning (1993) refinement to the Lo and MacKinlay (1989) variance ratio methodology is used to examine daily BIFFEX price, volume, and index quotes for randomness. Results suggest the possibility of seasonality in the index values between 1985 and 1989. Evidence of seasonality in the index suggests the possibility of the potential for exploitation by some market participants. However, evidence of randomness in the futures contract prices, suggests that index seasonality has not here-to fore been exploited.     

Exploiting volatility movements in the Sydney futures exchange's bank bill contract

An appropriate stochastic model was fitted to one year of data on the implied volatility of options on 90 day bank accepted bill futures contracts traded in the Sydney Futures Exchange. The model used was ARIMA augmented with day of the week variables, an option time to maturity variable, and recent values of historic volatility. The high ex-post predictive accuracy of the model was then employed as the central element of a strategy of buy low/sell high volatility.We employed two trading schemes with suitably constructed Delta neutral portfolios comprising bill futures and call and put options on those futures over a period of six months, to test whether speculative trading profit could be earned. The existence of trading profits before transaction costs validated the potential of the buy low/sell high volatility strategies to generate speculative profits. The absence of any such trading profits after transaction costs however, showed that the market pricing of these securities is such that the dependencies within implied volatility cannot be profitably exploited.This result may be interpreted as evidence supporting an hypothesis of a semi-strong form of market efficiency.     

Strategic noise traders and liquidity pressure with a physically deliverable futures contract

Do physically deliverable futures contracts induce liquidity pressure in the underlying spot market? The answer is believed to be no since the asset is delivered sometimes after the expiration of the contract so that the futures trader's payoff does not clearly depend on the price of the underlying stock at expiration. We construct a rational expectations equilibrium model in which a strategic uninformed trader induces liquidity pressure in the underlying spot market at the expiration of a physically deliverable futures contract. Liquidity pressure is the result of a pure informational advantage: if it is known that futures traders hedge their position in the spot market then a strategic trader with no information about the fundamental value of the underlying has an incentive to create noise in the futures market in order to gain information on the composition of the spot order flow at future auctions. We show that informed traders benefit from this form of strategic noise and that the efficiency of the prices remains unaffected.     

Dynamic price formation in a futures market via double auctions

Summary We report an exploratory study of the process of price formation in a speculative market in the absence of liquidity traders. Traders exchange a futures contract because they interpret information differently. We formulate trading as a sequence of anonymous double auctions and introduce a notion of bounded rationality in which traders use approximate models of market response in forming their bids. We prove existence of a perfect equilibrium in the sequential anonymous auctions game, and show that the equilibrium has a no-regret property. After learning the market price, a trader regrets neither the bid that he made nor the position that he holds. We show that trading volume is related to changes in the distribution of information in the economy. We also show that volume and expected change in price are related to two different attributes of the pattern of private information flow. Fundamentally, no particular relationship between the time series of these variables is always valid for all futures contracts. This point is emphasized by an example.I am thankful for useful comments made by Avraham Beja, James Gammil, Chi-fu Huang, David Scharfstein and three anonymous referees. Financial support from Stanford Graduate School Faculty Fellowship is gratefully acknowledged.     

Modelling risk premia in CO2 allowances spot and futures prices

This article analyzes the modelling of risk premia in CO₂ allowances spot and futures prices, valid for compliance under the EU Emissions Trading Scheme (EU ETS). Similarly to electricity markets, a salient characteristic of CO₂ allowances is that the theory of storage does not hold, as CO₂ allowances only exist on the balance sheets of companies regulated by the scheme. The main result features positive time-varying risk premia in CO₂ spot and futures prices, which are strictly higher for post-2012 contracts (€6–9/ton of CO₂) than for Phase II contracts (€0–6/ton of CO₂). Contrary to Benth et al.'s (2008) for electricity markets, a positive relationship between risk premia and time-to-maturity is found in the EU ETS. As for relative differences between CO₂ futures and spot prices, CO₂ futures traded between + 1% (December 2008 contract) and + 33% (December 2014 contract) above spot prices during February 2008–April 2009. Contrary to Bessembinder and Lemmon (2002) for the electricity market, a positive relationship between risk premia and the variance/skewness of CO₂ spot prices is found. The futures-spot bias to the EU ETS explains around 1–6% of the variance of CO₂ futures premia.     

On the risk premium in Nordic electricity futures prices

This paper examines empirically the relationship between electricity spot and futures prices, by analysing a decade of data for a set of short term-to-maturity futures contracts traded in the Nordic Power Exchange. It is found that, on average, there are significant positive risk premiums in short-term electricity futures prices. The significance and size of the premiums, however, varies seasonally over the year; whereas it is greatest during winter, it is zero in summer. It is also found that time-varying risk premiums are significantly related to unexpectedly low reservoir levels. Furthermore, before the unprecedented supply-shock that hit the market around the end of year 2002, the risk premiums were related to the variance and the skewness of future spot prices.     

Momentum and reversals in Taiwan index futures returns during periods of extreme trading imbalance

The study analyzes the relation between a trading imbalance metric that captures data observable by investors, and future momentum and reversals in Taiwan index futures returns. Standard regression analyses do not show any significant dynamic relations between daily index futures returns and the trading imbalance, regardless of whether the trading imbalance metric is lagged, contemporaneous, or leads the index futures return. However, when the analyses are focused on periods with extreme trading imbalances I find that the daily index futures returns exhibit significant reversals following periods of extreme (low) trading imbalances and low returns. I also find some evidence of residual momentum in consecutive daily index futures returns following periods of extreme (high) trading imbalances and high returns. Trading simulation, directional accuracy, and market timing tests show these effects to be economically significant, even after accounting for transaction costs.     

Futures markets and commodity options: Hedging and optimality in incomplete markets

This paper examines the allocational roles of futures markets and commodity options in multi-good and multi-period economies. In a continuous-time model with time-additive utilities and homogeneous beliefs, trading in “unconditional” futures contracts, the market portfolio and a riskless asset gives any Pareto-optimal allocation. Individuals' optimal holdings of futures contracts in the continuous-time model are related to their consumption bundles and to their risk tolerances. It is shown that both hedging and “reverse hedging” behavior are possible. In the general model with discrete trading, options on portfolios of commodity options are shown to permit any unconstrained Pareto-optimal allocation.     

Optimal gasoline hedging strategies using futures contracts and exchange-traded funds

This article employs a variety of econometric models (including OLS, VEC/VAR, DCC GARCH and a class of copula-based GARCH models) to estimate optimal hedge ratios for gasoline spot prices using gasoline exchange-traded funds (ETFs) and gasoline futures contracts. We then compare their performance using four different measures from the perspective of both their hedging objectives and trading position using four different measures: variance reduction measure, utility-based measure and two tail-based measures (value at risk and expected shortfall). The impact of the 2008 financial market crisis on hedging performance is also investigated. Our findings indicate that, in terms of variance reduction, the static models (OLS and VEC/VAR) are found to be the best hedging strategies. However, more sophisticated time-varying hedging strategies could outperform the static hedging models when the other measures are used. In addition, ETF hedging is a more effective hedging strategy than futures hedging during the high-volatility (crisis) period, but this is not always the case during the normal time (post-crisis) period.     

Are natural gas spot and futures prices predictable?

We answer two questions concerning natural gas spot and futures prices. The first is: Can natural gas futures prices predict natural gas spot prices? The second is: Are natural gas spot and futures prices weak form efficient or can they be predicted based on examination of historical data? To answer these questions, we use daily data for Henry Hub natural gas spot and futures prices. Our answer to the first question is that natural gas futures prices do not predict the magnitude of future natural gas spot prices any better than what would be predicted by a random walk model. This result has important implications for many financial analysts and policy institutions that have used commodity futures prices to predict movements in spot prices. The answer to the second question is that when we apply a unit root test that allows for heteroskedasticity and two structural breaks, natural gas spot and futures prices are predictable. We then simulate a contrarian trading strategy for spot and futures prices to show under what circumstances trading in spot and futures prices are also profitable. The results point to the need to accommodate heteroskedasticity when applying unit root tests to model energy spot and futures prices with high-frequency data, such as daily data.     

Order Flows,Investor Sentiments and Feedback Trade in Index Futures Market

This paper examines the presence of feedback trading, and investor sentiment drove feedback trading by traders in the Nifty 50 index futures contract in India. The results of the study using high-frequency data sampled at 10 min interval using VAR and contemporaneous VAR model as applied to market microstructure settings reveals negative evidence of feedback trade and investor sentiment-driven feedback trade in Nifty 50 futures contract. Further, consistency with noise trading hypothesis, order flows in Nifty 50 futures contract is less informative when traders are overly optimistic.

     

Insider trading and information revelation with the introduction of futures markets

We establish a theoretical model with informed trading in which both of individual stock futures and its underlying stock are traded in the market. With the introduction of the futures, the paper shows that an informed trader's position of futures usually motivates him or her to trade more aggressively in the stock market at the expiration day. This also worsens the adverse selection problem and makes the stock market become less liquid. Moreover, the increase of the informed trading accelerates the information revelation and improves market efficiency on the expiration date. Finally, our results suggest that price manipulation could be one factor that affects the market liquidity and market efficiency when the futures are introduced into the market.     

Market Architecture and Nonlinear Dynamics of Australian Stock and Futures Indices

This paper studies the All Ordinaries Index in Australia, and its futures contract known as the Share Price Index. We use a new form of smooth transition model to account for a variety of nonlinearities caused by transaction costs and other market/data imperfections, and given the recent interest in the effects of market automation on price discovery, we focus on how the nonlinear properties of the basis and returns have changed, now that floor trading in the futures contract has been replaced by electronic trading.     

Introducing the mini-futures contract on Ibex 35: implications for price discovery and volatility transmission

This paper analyzes the effects of the introduction of the mini-futures contract in the Spanish stock index futures market. The objective of the paper is twofold: (a) to analyze the potential destabilizing effect of the mini futures trading activity on the distribution of spot returns, and (b) to test whether the mini futures contract significantly contributes to the price discovery process. A non-parametric approach is used to estimate the density function of spot return conditional to both spot and futures trading volume. Empirical findings using 15-min intraday data reveal that the mini futures trading activity enhances the price discovery function of the derivative market and does not destabilize spot prices. A preliminary version of this paper has been previously published as a working paper of the Instituto Valenciano de Investigaciones Económicas, WP-EC 2004-13. M. Illueca and Juan A. Lafuente acknowledge financial support from Spanish ministry of Science and Technology through grants SEJ-2005-02776, and both SEJ2006-14354 and BEC-2003-03965, respectively.     

Expiration-day effects: Does settlement price matter?

We compare the expiration-day effects of two index futures contracts, TAIEX futures and SGX TW futures, which have the same underlying spot market, but different settlement mechanisms. By taking into account other factors such as open interests and institutional traders' activities, we find that the settlement mechanism and traders' structure affect expiration-day effects. In terms of minimizing expiration-day effects, the average price is better than the opening price, which in turn is better than the closing price settlement. Moreover, the results also demonstrate that foreign institutional traders' trading activities increase expiration-day effects.