A maximal affine stochastic volatility model of oil prices

This study develops and estimates a stochastic volatility model of commodity prices that nests many of the previous models in the literature. The model is an affine three‐factor model with one state variable driving the volatility and is maximal among all such models that are also identifiable. The model leads to quasi‐analytical formulas for futures and options prices. It allows for time‐varying correlation structures between the spot price and convenience yield, the spot price and its volatility, and the volatility and convenience yield. It allows for expected mean‐reversion in the short term and for an increasing expected long‐term price, and for time‐varying risk premia. Furthermore, the model allows for the situation in which options' prices depend on risk not fully spanned by futures prices. These properties are desirable and empirically important for modeling many commodities, especially crude oil. © 2009 Wiley Periodicals, Inc. Jrl Fut Mark 30:101–133, 2010     

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     

Natural gas prices and the gas storage report: Public news and volatility in energy futures markets

This study examines the short‐term volatility of natural gas prices through an examination of the intraday prices of the nearby natural gas futures contract traded on the New York Mercantile Exchange. The influence on volatility of what many regard as a key element of the information set influencing the natural gas market is investigated. Specifically, we examine the impact on natural gas futures price volatility of the Weekly American Gas Storage Survey report compiled and issued by the American Gas Association during the period January 1, 1999 through May 3, 2002 and the subsequent weekly report compiled and issued by the U.S. Energy Information Administration after May 6, 2002. We find that the weekly gas storage report announcement was responsible for considerable volatility at the time of its release and that volatility up to 30 minutes following the announcement was also higher than normal. Aside from these results, we document pronounced price volatility in this market both at the beginning of the day and at the end of the day and offer explanations for such behavior. Our results are robust to the manner in which the mean percentage change in the futures price is estimated and to correlation of these changes both within the day and across days. © 2004 Wiley Periodicals, Inc. Jrl Fut Mark 24:283–313, 2004     

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     

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     

Cointegration,unbiased expectations,and forecasting in the BIFFEX freight futures market

The relationship between freight cash and futures prices is investigated using cointegration econometrics. Results illustrate that the BIFFEX futures market is unbiased, and hence efficient for the current, one, two, and quarterly contract horizons. Since the futures contract is based on an index of various shipping routes, which has undergone several changes since its inception, stability in the relationship between the spot and futures rates is investigated using rolling cointegration techniques. Results indicate that the futures contract appears to have become more efficient over time in predicting the spot rate, and that the decrease in trading volume found in the BIFFEX market is not driven by a lack of efficiency in this market. Rather, the decrease in futures trading might be attributed to the growth rate of the freight forward market. This article incorporates the long‐run cointegrating relationships between cash and futures prices in a forecasting model and compares the forecasting performance of this model with several alternatives. It is found that while the futures price is the best predictor of future spot rates for the current‐month contract, time‐series models can outperform the futures contract at longer contract horizons. © 2000 John Wiley & Sons, Inc. Jrl Fut Mark 20:545–571, 2000.     

Causality in the VIX futures market

This study examines the price‐discovery function and information efficiency of a fast growing volatility futures market: the Chicago Board of Option Exchange VIX futures market. A linear Engle–Granger cointegration test with an error correction mechanism (ECM) shows that during the full sample period, VIX futures prices lead spot VIX index, which implies that the VIX futures market has some price‐discovery function. But a modified Baek and Brock nonlinear Granger test detects bi‐directional causality between VIX and VIX futures prices, suggesting that both spot and futures prices react simultaneously to new information. Quarter‐by‐quarter investigations show that, on average, the estimated parameters are not significantly different from zero, thus providing further evidence supporting information efficiency in the VIX futures market. © 2011 Wiley Periodicals, Inc. Jrl Fut Mark     

Extreme volatility,speculative efficiency,and the hedging effectiveness of the oil futures markets

This study investigates the efficiency of the New York Mercantile Exchange (NYMEX) Division light sweet crude oil futures contract market during recent periods of extreme conditional volatility. Crude oil futures contract prices are found to be cointegrated with spot prices and unbiased predictors of future spot prices, including the period prior to the onset of the Iraqi war and until the formation of the new Iraqi government in April 2005. Both futures and spot prices exhibit asymmetric volatility characteristics. Hedging performance is improved when asymmetries are accounted for. © 2007 Wiley Periodicals, Inc. Jrl Fut Mark 27:61–84, 2007     

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.     

Hedging in Futures and Options Markets with Basis Risk

This paper analyzes the hedging decisions for firms facing price and basis risk. Two conditions assumed in most models on optimal hedging are relaxed. Hence, (i) the spot price is not necessarily linear in both the settlement price and the basis risk and (ii) futures contracts and options on futures at different strike prices are available. The design of the first‐best hedging instrument is first derived and then it is used to examine the optimal hedging strategy in futures and options markets. The role of options as useful hedging tools is highlighted from the shape of the first‐best solution. © 2002 John Wiley & Sons, Inc. Jrl Fut Mark 22:59–72, 2002     

An N‐factor Gaussian model of oil futures prices

This article studies the ability of an N‐factor Gaussian model to explain the stochastic behavior of oil futures prices when estimated with the use of all available price information, as opposed to traditional approaches of aggregating data for a set of maturities. A Kalman filter estimation procedure that allows for a time‐dependent number of daily observations is used to calibrate the model. When applied to all daily oil futures price transactions from 1992 to 2001, the model performs very well, requiring at least three factors to explain the term structure of futures prices, but four factors to fit the volatility term structure. The model also performs very well for daily copper futures transactions from 1992 to 2001 and for out‐of‐sample daily oil futures transactions from 2002 to 2004. © 2006 Wiley Periodicals, Inc. Jrl Fut Mark 26:243–268, 2006     

Efficiency of the IBEX spot–futures basis: The impact of the mini‐futures

This paper considers whether the introduction of the mini‐futures contract for the Spanish Ibex index affects overall market efficiency. Using linear, non‐linear, and fractional integration modeling techniques for the basis term, results of this study suggest the following salient points. First, the equilibrium speed of adjustment is reduced after the introduction of the mini‐futures contract. This effect is particularly pronounced in the mini‐futures second year when its contracts are more heavily traded. Second, fractional integration tests support longer memory in the basis term after the contract introduction, again particularly in the second year. Third, the relationship between the full‐size and mini‐futures contracts appears highly efficient, with a quick speed of adjustment and short memory. Finally, an examination of the volatility dynamics suggests that in the second year of the mini‐futures contract shocks to spot return volatility exhibit longer memory. The results reported here suggest that the increased use of the mini‐futures contract after its introduction has had a detrimental impact on price discovery. © 2008 Wiley Periodicals, Inc. Jrl Fut Mark 28: 398–415, 2008     

Trading activity in stock index futures markets: The evidence of emerging markets

This study investigates the trading activity of the Taiwan Futures Exchange (TAIFEX) and Singapore Exchange Derivatives Trading Limited (SGX‐DT) Taiwan Stock Index Futures markets by analyzing the intraday patterns of volume and volatility. In addition, the market closure theory, which may explain such patterns, is examined. Overall, the trading pattern appears to be U‐shaped for the TAIFEX futures and U+W‐shaped for the SGX‐DT. For the SGX‐DT futures, volatility follows the same pattern as that of the number of price changes. For the TAIFEX futures, however, after the peak at the close of the spot market, the volatility in the TAIFEX futures drops consistently until the end of the day while volatility in the SGX‐DT still reaches a smaller peak at the close of the futures market. In addition, a visual inspection of the intraday patterns of these two markets shows that the market closure theory can effectively explain the intraday patterns of these two markets. The empirical results support the market closure theory in that liquidity demand from traders rebalancing their portfolios before and after market closures creates larger volume and volatility at both the open and close. © 2002 Wiley Periodicals, Inc. Jrl Fut Mark 22:983–1003, 2002     

Do volatility determinants vary across futures contracts? Insights from a smoothed Bayesian estimator

We apply a new Bayesian approach to multiple‐contract futures data. It allows the volatility of futures prices to depend upon physical inventories and the contract's time to delivery—and it allows those parametric effects to vary over time. We investigate price movements for lumber contracts over a 13‐year period and find a time‐varying negative relationship between lumber inventories and lumber futures price volatility. The Bayesian approach leads to different conclusions regarding the size of the inventory effect than does the standard method of parametric restrictions across contracts. The inventory effect is smaller for the most recent contracts when the inventory levels are larger. In contrast, the Bayesian approach does not lead to substantively different conclusions about the time‐to‐delivery effect than do traditional classical methods. © 2009 Wiley Periodicals, Inc. Jrl Fut Mark 30:257–277, 2010     

Volatility spillover effects and cross hedging in corn and crude oil futures

Using a volatility spillover model, we find evidence of significant spillovers from crude oil prices to corn cash and futures prices, and that these spillover effects are time‐varying. Results reveal that corn markets have become much more connected to crude oil markets after the introduction of the Energy Policy Act of 2005. Furthermore, when the ethanol–gasoline consumption ratio exceeds a critical level, crude oil prices transmit positive volatility spillovers into corn prices and movements in corn prices are more energy‐driven. Based on this strong volatility link between crude oil and corn prices, a new cross‐hedging strategy for managing corn price risk using oil futures is examined and its performance is studied. Results show that this cross‐hedging strategy provides only slightly better hedging performance compared with traditional hedging in corn futures markets alone. The implication is that hedging corn price risk in corn futures markets alone can still provide relatively satisfactory performance in the biofuel era. © 2010 Wiley Periodicals, Inc. Jrl Fut Mark     

Scheduled announcements and volatility patterns: The effects of monetary policy committee announcements on LIBOR and short sterling futures and options

Both the UK spot and futures markets in short‐term interest rates are found to react strongly to surprises in the scheduled announcements of the repo rate and RPI. Therefore, these announcements should also affect the market for options on short‐term interest rate futures. Because the repo rate and RPI announcements are scheduled, the options market can predict the days on which announcement shocks may hit, and build this information into its volatility expectations. It is argued that the volatility used in pricing options should alter over time in a predictable nonlinear manner that varies with contract maturity and the number of forthcoming announcements; but is independent of announcement content. The empirical results support this hypothesis. © 2003 Wiley Periodicals, Inc. Jrl Fut Mark 23:773–797, 2003     

Examining futures price changes and volatility on the trading day after a limit‐lock day

This paper examines the effect that price limits have on futures prices by testing what happens to price changes and volatility on the trading day following a limit‐lock day. The results show evidence that prices continue to rise on average the day after an up‐limit day. In addition, limits appear to influence price volatility for some but not all of the futures contracts. However, since the findings vary across the different commodity futures contracts, it is likely that limits do not directly impact price volatility. © 2000 John Wiley & Sons, Inc. Jrl Fut Mark 20:445–466, 2000     

A STRUCTURAL RISK‐NEUTRAL MODEL FOR PRICING AND HEDGING POWER DERIVATIVES

We develop a structural risk‐neutral model for energy market modifying along several directions the approach introduced in Aïd et al. In particular, a scarcity function is introduced to allow important deviations of the spot price from the marginal fuel price, producing price spikes. We focus on pricing and hedging electricity derivatives. The hedging instruments are forward contracts on fuels and electricity. The presence of production capacities and electricity demand makes such a market incomplete. We follow a local risk minimization approach to price and hedge energy derivatives. Despite the richness of information included in the spot model, we obtain closed‐form formulae for futures prices and semiexplicit formulae for spread options and European options on electricity forward contracts. An analysis of the electricity price risk premium is provided showing the contribution of demand and capacity to the futures prices. We show that when far from delivery, electricity futures behave like a basket of futures on fuels.     

The effectiveness of coordinating price limits across futures and spot markets

We extend the work of Brennan ( 1986 ) to investigate whether the imposition of spot price limits can further reduce the default risk and lower the effective margin requirement for a futures contract that is already under price limits. Our results show that spot price limits do indeed further reduce the default risk and margin requirement effectively. In addition, the more precise the information is that comes from the spot market, the more the spot price limit rule constrains the information available to the losing party. The default probability, contract costs, and margin requirements are then lowered to a greater degree. Furthermore, for a given margin, both spot price limits and futures price limits can partially substitute for each other in ensuring contract performance. The common practice of imposing equal price limits on both the spot and futures markets, though not coinciding with the efficient contract design, has a lower contract cost and margin requirement than that without imposing spot price limits. © 2003 Wiley Periodicals, Inc. Jrl Fut Mark 23:577–602, 2003     

Reversing the lead,or a series of unfortunate events? NYMEX,ICE, and Amaranth

A number of studies compare the efficiency and transparency of floor trading with automated/electronic trading systems in the competition for order flow. Although most of these studies find that electronic systems lead price discovery, a few studies highlight the weaknesses of electronic trading in highly volatile market conditions. A series of unusual events in 2006, sparking extreme volatility in natural gas futures trading, provide an ideal setting to revisit the resilience of trading system price leadership in the face of high volatility. We estimate time‐varying Hasbrouck‐style information shares to investigate the intertemporal and cross‐sectional dynamics in price discovery. The results strongly suggest that the information share is time‐dependent and contract‐dependent. Floor trading dominates price discovery in the less liquid longer‐maturity contracts, whereas electronic trading dominates price discovery in the most liquid spot‐month contract. We find that the floor trading information share increases significantly with realized volatility. © 2009 Wiley Periodicals, Inc. Jrl Fut Mark 29:1130–1160, 2009