Mispricing of index futures contracts and short sales constraints

This article examines if changes in short sales constraints affect the extent to which index futures contracts are mispriced. In particular, the study analyzes the mispricing of the Hong Kong Hang Seng Index futures contracts. Tests are conducted over three distinct regulatory regimes relating to the short selling of stocks in Hong Kong. This permits a study of how changes in short selling regulations affect the mispricing of futures contracts. The study indicates that relaxing the constraints on short selling reduces the extent of futures mispricing. Multiple regression analysis is used to test the relationship between the magnitude of mispricing and various economic factors including cash market volatility, time-to-maturity of the contract, trading cost, and dividend payout rates. The study also finds that lifting of the short selling restrictions speeds up market adjustment, especially when a long-hedge (long futures, short stock) signal is detected. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19: 695–715, 1999     

The pricing of electricity futures: Evidence from the European energy exchange

This study investigates the pricing of electricity futures at the European Energy Exchange (EEX) over the period 2002 through 2004. To calculate theoretical contract values, the reduced‐form models of J. J. Lucia and E. S. Schwartz (2002) are used, and a thorough empirical analysis by means of an out‐of‐sample test is conducted for both one‐ and two‐factor models, incorporating a constant non‐zero price of risk. Although the models are proven to capture all basic spot market characteristics and provide an accurate in‐the‐sample fit to observed futures prices, the forecasting performance is subject to biases. For instance, it was found that the relative mispricing depends on both the spot price level and the remaining time‐to‐maturity of the futures contracts. © 2007 Wiley Periodicals, Inc. Jrl Fut Mark 27:387–410, 2007     

Approximation for convenience yield in commodity futures pricing

The pricing of commodity futures contracts is important both for professionals and academics. It is often argued that futures prices include a convenience yield, and this article uses a simple trading strategy to approximate the impact of convenience yields. The approximation requires only three variables—underlying asset price volatility, futures contract price volatility, and the futures contract time to maturity. The approximation is tested using spot and futures prices from the London Metals Exchange contracts for copper, lead, and zinc with quarterly observations drawn from a 25‐year period from 1975 to 2000. Matching Euro‐Market interest rates are used to estimate the risk‐free rate. The convenience yield approximation is both statistically and economically important in explaining variation between the futures price and the spot price after adjustment for interest rates. © 2002 Wiley Periodicals, Inc. Jrl Fut Mark 22:1005–1017, 2002     

Clustering in the futures market: Evidence from S&P 500 futures contracts

We document trade price clustering in the futures markets. We find clustering at prices of x.00 and x.50 for S&P 500 futures contracts. While trade price clustering is evident throughout time to maturity of these contracts, there is a dramatic change when the S&P 500 futures contract is designated a front‐month contract (decrease in clustering) and a back‐month contract (increase in clustering). We find that trade price clustering is a positive function of volatility and a negative function of volume or open interest. In addition, we find a high degree of clustering in the daily opening and closing prices, but a lower degree of clustering in the settlement prices. © 2004 Wiley Periodicals, Inc. Jrl Fut Mark 24:413–428, 2004     

Maturity effects in the Mexican interest rate futures market

This study investigates the relationship between volatility and contract expiration for the case of Mexican interest rate futures. Specifically, it examines the hypothesis that the volatility of futures prices should increase as contracts approach expiration (the “maturity effect”). Using panel data techniques, the study assesses the differences in volatility patterns between contracts. The results show that although the maturity effect was sometimes present, the inverse effect prevails; volatility decreases as expiration approaches. On the basis of the premises of the negative covariance hypothesis, the study provides additional criteria that explain this behavior in terms of the term structure dynamics. © 2010 Wiley Periodicals, Inc. Jrl Fut Mark 31:371–393, 2011     

The time-to-maturity pattern of futures price sensitivity to news

This paper examines the effect time-to-maturity has on how sensitive futures prices are to news flows. Unscheduled daily news flows that relate to the underlying asset of a futures contract are related to the daily realized volatility of futures to calculate a price-news sensitivity ratio. The observed pattern follows an inverted U-shape relationship and has a bearing on whether the maturity effect will be noticeable in a futures contract. This paper also shows that by examining the peak-to-maturity of the price sensitivity to news pattern, it is possible to better identify which contracts are more likely to yield higher volatility.     

An empirical examination of the relation between futures spreads volatility,volume, and open interest

This study investigates the relation between petroleum futures spread variability, trading volume, and open interest in an attempt to uncover the source(s) of variability in futures spreads. The study finds that contemporaneous (lagged) volume and open interest provide significant explanation for futures spreads volatility when entered separately. The study also shows that lagged volume and lagged open interest, when entered in the conditional variance equation simultaneously, have greater effect on volatility and substantially reduce the persistence of volatility. This finding seems to support the sequential information arrival hypothesis of Copeland (1976). Finally, the findings of this study also suggest a degree of market inefficiency in petroleum futures spreads. © 2002 Wiley Periodicals, Inc. Jrl Fut Mark 22:1083–1102, 2002     

A hedging deficiency in eurodollar futures

The eurodollar futures contract of the Chicago Mercantile Exchange is arguably the most successful of all futures contracts. The contract is structured such that its price does not converge to the price of the underlying eurodollar time deposit. Ignoring the daily settlement, one typically assumes that a eurodollar futures contract perfectly hedges an anticipated loan pegged to LIBOR, provided the loan rate is set at the eurodollar expiration. This article demonstrates that this hedge is not perfect, leaving a risk empirically estimated at four basis points, a seemingly small amount but considerably larger than the bid–ask spread on the futures. © 2006 Wiley Periodicals, Inc. Jrl Fut Mark 26:189–207, 2006     

An empirical examination of the SIMEX Nikkei 225 futures contract around the Kobé earthquake and the Barings Bank collapse

This study examines the levels and interrelationships of volatility, volume, open interest and effective bid-ask spread on the Nikkei 225 futures contract on SIMEX. The sample chosen is critical; conclusions regarding the effect of the Kobé earthquake of January 1995 and the resulting collapse of Barings Bank in February 1995 can be uncovered. The analysis uses graphs of the levels of the variables and an assessment of the variables using a vector autoregression and impulse response functions. Volume and open interest temporarily increased, whereas the increase in effective bid-ask spread is more permanent. This seems to be due to the sensitivity that each of the variables develops to volatility as a result of these information shocks. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19: 1–29, 1999     

The Costs of Arbitrage and Futures Market Trading Activity

Abstract Standardizing a futures contract’s specifications to enhance its transfer-ability is problematic for any commodity whose cash market adopts relational contracting procedures. Standardization implies the contract’s value cannot be completely determined by competitive arbitrage order flow, inhibiting the market’s price discovery function, and leaving the futures price susceptible to manipulation. These effects may result in the market’s failure. The model, based on the theory of storage, predicts that contracts with a higher spread-open position price volatility are more likely to contain a range of arbitrage indeterminacy, hence to experience difficulties in sustaining trading. The prediction is supported in an empirical examination of 104 US futures markets. The range of indeterminacy also increases the informational requirements of spread traders, reducing the effectiveness of spread arbitrage in maintaining the equilibrium intertemporal futures pricing relationship. Detailed evidence from 15 US contract markets demonstrates spread arbitrage is less effective in contract markets which subsequently fail.     

Determinants of Nikkei futures mispricing in international markets: Dividend clustering,currency risk,and transaction costs

This paper develops a comprehensive modified cost-of-carry model to study the mispricing of Nikkei 225 index futures contracts traded in Osaka, Singapore, and Chicago based on a new 19-year data set. Using this improved model, we find that dividend clustering, currency risk, and transaction costs all play an essential role in the estimation of Nikkei mispricing. An exponential smooth transition autoregressive-GARCH model is used to describe the international dynamics of Nikkei mispricing. The results indicate that generally mean reversion in mispricing and limits to arbitrage are driven more by transaction costs than by heterogeneous investors.     

Complements or substitutes? Equivalent futures contract markets—the case of corn and soybean futures on U.S. and Japanese exchanges

This article examines the relationship between corn and soybean futures volumes for contracts traded in the United States and Japan. Because the contract specifications for corn and soybeans futures traded on the Chicago Board of Trade (CBOT), the Tokyo Grain Exchange (TGE), and the Kanmon Commodity Exchange (KCE) are highly similar, the existence of interactions might be expected. Previous research has identified price relationships between these similar contracts. With the advent of agricultural trading on the CBOT's Project A overnight electronic trading system, an overlap of trading times of the U.S. and Japanese exchanges for these commodity contracts resulted. An analysis of TGE and KCE corn and soybean futures volumes indicates that these contracts, rather than acting as substitutes, exhibit a complementary relationship. © 2002 Wiley Periodicals, Inc. Jrl Fut Mark 22:355–370, 2002     

Substitution between revenue futures and price futures contracts: A note

In recent years, commercial interest has been expressed in agricultural revenue insurance instruments. Participating parties may look to futures markets to offset assumed positions. In this note, conditions are identified such that revenue futures contracts are perfect substitutes for price futures contracts. If these conditions approximate reality, then it would seem questionable whether sufficient interest would exist to sustain markets in both futures contracts. © 2002 Wiley Periodicals, Inc. Jrl Fut Mark 22:387–391, 2002     

The Valuation of Equity Futures on the Tokyo Stock Exchange: 1920–1923

The futures price of an asset should depend on the spot price of that asset, the interest rate, cash flows during the contract term, the convenience yield, and storage costs. Despite many tests of the spot–future relation for commodities in historical periods, there have been no tests of this historical relation for equities. We price single‐stock equity futures on the Tokyo Stock Exchange between 1920 and 1923 and find that mispricing is considerably worse than in contemporary U.S. markets, after adjusting for (unavoidable) asynchronous data issues. The main cause of the mispricing is short‐sales constraints, rather than investor naivety. © 2012 Wiley Periodicals, Inc. Jrl Fut Mark     

Open interest,cross listing,and information shocks

This study examines the characteristics and behavior of the demand for hedging, proxied by open interest, for the cross‐listed Euribor futures contract traded at Euronext‐LIFFE and Eurex. The study is unique in its investigation of the simultaneous determinants of open interest in a cross‐listed setting. It also assesses the impact of shocks on traders' demand for hedging and shows how the 9/11 terrorist attacks and the credit crunch influence the level of dependency between Euronext‐LIFFE and Eurex. Differences of opinion, ECB Governing Council meetings, days of the week, contract maturity, illiquidity, and volatility are investigated as potential determinants of open interest. © 2010 Wiley Periodicals, Inc. Jrl Fut Mark 31:755–778, 2011     

Do tax-exempt yields adjust slowly to substantial changes in taxable yields?

This paper examines the profitability of two futures trading strategies: a municipal bond futures contract strategy and a spread strategy consisting of a municipal bond futures contract and a Treasury bond futures contract. Both strategies are designed to exploit a slow municipal yield adjustment following changes in Treasury yields. We find economically significant profits to both strategies. Average holding period returns per trade for both strategies tend to increase with the magnitude of the Treasury yield change. Profit distributions associated with various Treasury yield change thresholds tend to be positively skewed, and median profits are significantly lower than average profits. The profitability results are consistent with slow municipal yield adjustments. © 2008 Wiley Periodicals, Inc. Jrl Fut Mark 28:763–789, 2008     

Volatility and maturity effects in the Nikkei index futures

Many financial data series are found to exhibit stochastic volatility. Some of these time series are constructed from contracts with time-varying maturities. In this paper, we focus on index futures, an important subclass of such time series. We propose a bivariate GARCH model with the maturity effect to describe the joint dynamics of the spot index and the futures-spot basis. The setup makes it possible to examine the Samuelson effect as well as to compare the hedge ratios under scenarios with and without the maturity effect. The Nikkei-225 index and its futures are used in our empirical analysis. Contrary to the Samuelson effect, we find that the volatility of the futures price decreases when the contract is closer to its maturity. We also apply our model to futures hedging, and find that both the optimal hedge ratio and the hedging effectiveness critically depend on both the maturity and GARCH effects. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19: 895–909, 1999     

In search of the convexity adjustment: Evidence from the sterling futures and IMM FRA markets

This study examines daily and intraday data on sterling interest rate futures and IMM forward rate agreement (FRA) contracts for evidence of the convexity adjustment in FRA quotes. The futures/FRA differential is marginally negative, contrary to the predictions of convexity models. Standard statistical tests confirm that the futures/FRA differential does not differ between contract maturities. Regression analysis also fails to find any support for the predicted positive relationships between the differential and the term to settlement and volatility of interest rates. These results suggest that dealers in the sterling FRA market do not price convexity into quotes on FRA contracts. © 2008 Wiley Periodicals, Inc. Jrl Fut Mark 28:617–633, 2008     

How electronic trading affects bid‐ask spreads and arbitrage efficiency between index futures and options

This paper examines the impact of switching to electronic trading on the relative pricing efficiency of Hang Sang Index futures and options contracts traded on the Hong Kong exchange. The study is motivated by the recent shift in 2000 from the pit to an electronic trading platform. Electronic trading leads to lower bid‐ask spreads and less price clustering than floor trading in both the options and futures markets. Mispricing between futures and options drops significantly after the change. Quicker correction of mispricing indicates a significant improvement in dynamic inter‐market arbitrage efficiency with electronic trading. © 2005 Wiley Periodicals, Inc. Jrl Fut Mark 25:375–398, 2005     

Minimum variance cross hedging under mean‐reverting spreads,stochastic convenience yields,and jumps: Application to the airline industry

Exchange traded futures contracts often are not written on the specific asset that is a source of risk to a firm. The firm may attempt to manage this risk using futures contracts written on a related asset. This cross hedge exposes the firm to a new risk, the spread between the asset underlying the futures contract and the asset that the firm wants to hedge. Using the specific case of the airline industry as motivation, we derive the minimum variance cross hedge assuming a two‐factor diffusion model for the underlying asset and a stochastic, mean‐reverting spread. The result is a time‐varying hedge ratio that can be applied to any hedging horizon. We also consider the effect of jumps in the underlying asset. We use simulations and empirical tests of crude oil, jet fuel cross hedges to demonstrate the hedging effectiveness of the model. © 2009 Wiley Periodicals, Inc. Jrl Fut Mark 29:736–756, 2009