Asymmetric information in commodity futures markets: Theory and empirical evidence

This article examines the theoretical and empirical implications of asymmetric information in commodity futures markets. In particular, it formulates and tests a theoretical model that recognizes two distinct categories of traders: hedgers, who participate in both spot and futures markets, and speculators, who participate only in the futures market. Speculators are assumed to possess differential information about the realized values of selected random variables. Multiperiod futures market equilibria are derived under competitive conditions, and the ability of futures markets to forecast changes in equilibrium spot market prices are examined. The key variable is shown to be the randomness and informational asymmetry in the aggregate supply by participating hedgers in the spot market, whose absence turns out to be the major determinant of the revelation of informational asymmetry. Moreover, under the assumption of independence of error forecasts for prices and spot market supplies, it is shown that futures market equilibrium ends up with linear expressions for prices and futures contract volumes. These linear expressions are then used to develop empirically testable models. The main empirical implications in these models revolve around the role of the basis as a predictor of future spot price changes. The paper provides an empirical investigation of these implications, using three commodities traded on the Winnipeg Commodity Exchange (WCE). © 1998 John Wiley & Sons, Inc. Jrl Fut Mark 18:803–825, 1998     

The relative efficiency of commodity futures markets

The ability of futures markets to predict subsequent spot prices has been a controversial topic for a number of years. Empirical evidence to date is mixed; for any given market, some studies find evidence of efficiency, others of inefficiency. In part, these apparently conflicting findings reflect differences in the time periods analyzed and the methods chosen for testing. A limitation of existing tests is the classification of markets as either efficient or inefficient with no assessment of the degree to which efficiency is present. This article presents tests for unbiasedness and efficiency across a range of commodity and financial futures markets, using a cointegration methodology, and develops a measure of relative efficiency. In general, the findings suggest that spot and futures prices are cointegrated with a slope coefficient that is close to unity, so that the postulated long-run relationship is accepted. However, there is evidence that the long-run relationship does not hold in the short run; specifically, changes in the spot price are explained by lagged differences in spot and futures prices as well as by the basis. This suggests that market inefficiencies exist in the sense that past information can be used by agents to predict spot price movements. A measure of the relative degree of inefficiency (based on forecast error variances) is then used to compare the performance of different markets. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19: 413–432, 1999     

Market efficiency among futures with different maturities: Evidence from the crude oil futures market

Although many studies have investigated market efficiency of spot and futures prices, that among futures with different maturities has not been studied extensively. In this study, market efficiency and unbiasedness among such futures are defined and the concept of “consistently efficient (or consistently efficient and unbiased) market within n‐month maturity” is introduced. According to this definition, market efficiency and unbiasedness among WTI futures with different maturities are tested using cointegration analysis, and short‐term market efficiency, using an error correction model and GARCH‐M‐ECM. The results show that WTI futures are consistently efficient within 8‐month maturity and consistently efficient and unbiased within 2‐month maturity. © 2010 Wiley Periodicals, Inc. Jrl Fut Mark 31:487–501, 2011     

Noninformative and informative tests of efficiency in three energy futures markets

This article presents a critique of tests of market efficiency commonly applied to energy futures markets. Most of this literature fails to deal adequately with the endogeneity, nonstationarity, and cointegration characteristics of spot and futures prices, resulting in tests that are not informative about market efficiency. Consistent with this literature, application of these noninformative tests to spot and futures prices from three energy markets is generally not supportive of market efficiency. The article also presents two alternative tests of efficiency that properly deal with the stochastic features of these price series. Nonstationary data can be modeled with cointegration methods, allowing valid tests of the efficiency hypothesis. Alternatively, testing the equivalence of the data generation processes of the spot and futures prices provides an informative approach to efficiency testing with stationary data that does not suffer from endogeneity problems. Application of these two tests is largely supportive of weak and semistrong efficiency in three energy futures markets. © 1998 John Wiley & Sons, Inc. Jrl Fut Mark 18: 939–964, 1998     

Bias and backwardation in natural gas futures prices

This paper tests the fair‐game efficient‐markets hypothesis for the natural gas futures prices over the period 1990 through 2003. We find evidence consistent with the Keynesian notion of normal backwardation. Regressing the future spot prices on the lagged futures prices and using the Stock‐Watson (1993) procedure to correct for the correlation between the error terms and the futures prices, we find that natural gas futures are biased predictors of the corresponding future spot prices for contracts ranging from 3 to 12 months. These results cast a serious doubt on the commonly held view that natural gas futures sell at a premium over the expected future spot prices, and that this bias is due to the systematic risk of the futures price movements represented by a negative “beta.” We also find evidence for the Samuelson effect. © 2005 Wiley Periodicals, Inc. Jrl Fut Mark 25:281–308, 2005     

Risk premiums and predictive ability of BAX futures

This study provides an in‐depth analysis of risk premiums in the Canadian Bankers' Acceptances futures (BAX) market. The predictive regressions for excess and holding‐period returns on BAX futures lend empirical support to the presence of time‐varying risk premiums especially at longer horizons. Despite the evidence of time variation in the risk premium, however, the unbiasedness of the basis as a predictor of spot returns in forecast efficiency regressions cannot be rejected. The out‐of‐sample forecasts of spot returns demonstrate the excellent predictive ability of models that exploit the restrictions implied by the unbiasedness hypothesis. Overall, our findings support the presence of a slowly moving risk premium and entail important practical implications for measuring monetary policy expectations and portfolio allocation. © 2010 Wiley Periodicals, Inc. Jrl Fut Mark     

The relationship between spot and futures prices: Evidence from the crude oil market

This article examines the relationship between the spot and futures prices of WTI crude oil using a sample of daily data. Linear causality testing reveals that futures prices lead spot prices, but nonlinear causality testing reveals a bidirectional effect. This result suggests that both spot and futures markets react simultaneously to new information. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19: 175–193, 1999     

Illiquidity transmission from spot to futures markets

We develop a model of illiquidity transmission from spot to futures markets that formalizes the derivative hedge theory of Cho and Engle (1999). The model shows that spot market illiquidity does not translate one to one to the futures market but, rather, interacts with price risk, liquidity risk, and the risk aversion of the market maker. The model's predictions are tested empirically with data from the stock market and markets for single-stock futures and index futures. The results support our model and show that the derivative hedge theory provides an explanation for the liquidity link between spot and futures markets.     

A first look at the empirical relation between spot and futures electricity prices in the United States

In this article we investigate the statistical properties of wholesale electricity spot and futures prices traded on the New York Mercantile Exchange for delivery at the California–Oregon Border. Using daily data for the years 1998 and 1999, we find that many of the characteristics of the electricity market can be viewed to be broadly consistent with efficient markets. The futures risk premium for 6‐month futures contracts is estimated to be 0.1328% per day or about 4% per month. Using a GARCH specification, we estimate minimum variance hedge ratios for electricity futures. Finally, we study the dynamic relation between spot and futures prices using an Exponential GARCH model and between the spot and futures returns series using a vector autoregression. © 2003 Wiley Periodicals, Inc. Jrl Fut Mark 23:931–955, 2003     

A further investigation of the lead–lag relationship between the spot market and stock index futures: Early evidence from Korea

In this article, we investigate possible lead and lag relationship in returns and volatilities between cash and futures markets in Korea. Utilizing intraday data from the newly established futures market in Korea, we find that the futures market leads the cash market by as long as 30 minutes. This result is consistent with previous studies for the U.S. and other countries’ futures markets. With regard to volatility interaction between spot and futures markets, we find that, unlike the above results for returns, a bidirectional causality is more prevalent between cash and futures markets, and this relationship is entirely sample dependent. We also find that the trading volume has significant explanatory power for volatility changes in both spot and futures markets. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19: 217–232, 1999     

Do futures prices help forecast the spot price?

This study proposes a futures‐based unobserved components model for commodity spot prices. Prices quoted at the same time incorporate the same information, but are affected differently, resulting in the different shapes of futures curves. This model utilizes information from part of the futures curve to improve forecasting accuracy of the spot price. Applying this model to oil market data, I find that the model forecasts outperform the literature benchmark (the no‐change forecast) and futures prices forecasts in multiple dimensions, with smaller average error variation over the sample period and higher chance of smaller absolute error in each period.     

Role of delivery options in basis convergence

The corn futures contract, traded on the Chicago Board of Trade, provides sellers with delivery options about the timing of delivery, the location of delivery, and the grade to be delivered. These options presumably have values that can vary from one delivery month to the next. The joint values of the timing and location options are estimated for each delivery month for the years 1989 through 1997. These estimates are then used in regression models to determine the degree to which they influence basis variability on the first day of the maturity month. Econometric models are also developed to see if the estimated implicit options values are useful in improving the forecasts of basis convergence over the 2‐month period prior to maturity. The results suggested that variation in the delivery options values in the corn futures contract does indeed help explain basis variability on the first day of maturity. An option‐value variable, based on estimated values two months prior to maturity, resulted in occasional, small improvements (from a statistical point of view) in the precision of forecasts. The existence of delivery options increases basis variability at maturity, but it is difficult to use this information to improve forecasts of basis convergence. One limitation of the analysis is that the Chicago cash market had few transactions per day during the sample period, and hence the reported spot prices may be inadequate for making high‐quality estimates of the options values. © 2002 Wiley Periodicals, Inc. Jrl Fut Mark 22:783–809, 2002     

Investor Sentiment and Return Predictability in Agricultural Futures Markets

This study examines the usefulness of trader‐position‐based sentiment index for forecasting future prices in six major agricultural futures markets. It has been found that large speculator sentiment forecasts price continuations. In contrast, large hedger sentiment predicts price reversals. Small trader sentiment hardly forecasts future market movements. An investigation was performed into various sentiment‐based timing strategies, and it was found that the combination of extreme large trader sentiments provides the strongest timing signal. These results are generally consistent with the hedging‐pressure theory, suggesting that hedgers pay risk premiums to transfer nonmarketable risks in futures markets. Moreover, it does not appear that large speculators in the futures markets possess any superior forecasting ability. © 2001 John Wiley & Sons, Inc. Jrl Fut Mark 21:929–952, 2001     

Arbitrage,cointegration, and the joint dynamics of prices across discrete commodity futures auctions

Underlying the search for arbitrage opportunities across commodity futures markets that differ in market structure is the idea that the futures prices for similar commodities that are traded on different exchanges adjusted for differences in currency, delivery time (if any), location, and market structure are equal. This article examines price linkages in competing discrete commodity futures auction markets. We find no evidence of cointegration of futures prices of similar commodities traded on two contemporaneous discrete auction futures exchanges in Asia. We also find no evidence of arbitrage activities across these two Asian exchanges, though this does not preclude arbitrage activities with North American continuous auction markets. This lack of cointegration may be due to nonstationarities in the trading cost component. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19: 799–815, 1999     

Is the Australian wool futures market efficient as a predictor of spot prices?

Giles and Goss (1980) have suggested that, if a futures market provides a forward pricing function, then it is an efficient market. In this article a simple test for whether the Australian Wool Futures market is efficient is proposed. The test is based on applying cointegration techniques to test the Law of One Price over a three, six, nine, and twelve month spread of futures prices. We found that the futures market is efficient for up to a six-month spread, but no further into the future. Because futures market prices can be used to predict spot prices up to six months in advance, woolgrowers can use the futures price to assess when they market their clip, but not for longer-term production planning decisions. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19: 565–582, 1999     

Valuation of futures and commodity options with information costs

In this article, futures and commodity options are analyzed in the context of Merton's (1987) model of capital market equilibrium with incomplete information. First, following Dusak (1973) and Black (1976), the conditions under which Merton's model can be applied to the valuation of forward and futures contracts are proposed. Then an application to futures markets is given. We provide a partial differential equation and the formulas for European commodity options, futures contracts, and American options in the same context. The models are simulated and compared to standard models with no information costs. We find that model prices are not significantly different from standard model prices. However, our models correct for some pricing biases in standard models. In particular, they reduce the overvaluation bias for European and American commodity options. It seems that the costs of gathering and processing information regarding the option and its underlying asset play a role in explaining the biases observed in standard models. This work can be applied to other futures markets. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19: 645–664, 1999     

Intertemporal volatility and price interactions between Australian and Japanese spot and futures stock index markets

Previous studies have examined causality within and between different spot and futures markets with a motivation to discover market comovements, price leadership effects, and, more recently, volatility spillovers across markets. However, the empirical framework within which this is accomplished tends not to analyze explicitly foreign spillover effects upon a spot–futures relationship, which may significantly alter the equilibrium between these markets. This will then have a direct impact upon the estimation of dynamic risk adjustments that occur from the interaction between these markets. This article develops a quadvariate simultaneous-equation EC-ARCH model with an emphasis on volatility spillovers as a better alternative methodology to evaluate these relationships from a different perspective. This model is applied to examine the interaction between the Australian and Japanese spot and futures stock index markets, which allows for an Australian or Japanese futures trader to analyze the impact of foreign cash and futures markets, as well as the local cash market, on the local futures market in a single coherent framework. This type of analysis is not possible using previous paradigms, because they allow the trader only to examine the impact of local cash and foreign futures markets in separate settings. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19: 523–540, 1999     

The information flow and market efficiency between the U.S. and Chinese aluminum and copper futures markets

This study examines the information flow and market efficiency between the metallurgical futures markets of the United States and China over a ten‐year span from 1999 to 2009. There were structural breaks in the aluminum and copper futures price series for the New York Mercantile Exchange (NYMEX) and Shanghai Futures Exchange (SHFE) between 2006 and 2008. The New York and Shanghai markets are cointegrated, indicating an equilibrium relationship between the two markets. Trading strategies are implemented to explore the error‐correction process. The overall results show that U.S. and Shanghai futures prices are closely related and both markets are comparably efficient on a daily basis. The U.S. market does not appear to be more efficient than the Chinese market in incorporating information into prices. © 2010 Wiley Periodicals, Inc. Jrl Fut Mark     

Price discovery in the foreign exchange futures market

Examination is made of the relative contributions to price discovery of the floor and electronically traded euro FX and Japanese yen futures markets and the corresponding retail on‐line foreign exchange spot markets. GLOBEX electronic futures contracts provide the most price discovery in the euro; the on‐line trading spot market provides the most in the Japanese yen. The floor‐traded futures markets contribute the least to price discovery in both the euro and the Japanese yen markets. The overall results show that electronic trading platforms facilitate price discovery more efficiently than floor trading. Futures traders may also extract information from on‐line spot prices. © 2006 Wiley Periodicals, Inc. Jrl Fut Mark 26:1131–1143, 2006     

Testing the rate forecasting consistency of major foreign currency futures

This paper examines the forecasting accuracy of currency futures markets in Canadian Dollars, British Pounds, Japanese Yen, German Marks, and Swiss Francs in predicting the actual spot rates that will exist in the spot market for these currencies. A second objective is to determine if the accuracy of the forecast is related to the time to maturity of the currency futures contract relative to the actual spot rate for that currency. The results indicate that the currency futures market appears to be a reasonably good forecaster of future currency spot rates.