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Futures Prices

Hendrik S. Houthakker and Peter J. Williamson

in The Economics of Financial Markets

The previous chapter outlined the nature of futures contracts and some of the institutional aspects of the markets in which they are traded; this chapter analyzes the forces that determine the prices ... More

The previous chapter outlined the nature of futures contracts and some of the institutional aspects of the markets in which they are traded; this chapter analyzes the forces that determine the prices of different futures contracts, their relationship to the current market price (known as the spot price), and derives a satisfactory theory of futures prices. Different determinants are explored of the prices of both commodity futures (contracts based on a tangible commodity) and financial futures (those based on another financial instrument or index). After looking at the role of futures in ‘programme trading’ and the realities of so‐called portfolio insurance through the use of futures and options – a concept that was put to the test by the ‘Black Monday’ crash of 1987 – the chapter concludes by discussing futures as an investment. The five sections of the chapter (which is a discussion with respect to the USA) are as follows: Profits and losses on various transactions; Relations among spot and futures prices; Hedgers, speculators, and market equilibrium; The role of expectations; and Futures and portfolio management.Less

Futures Contracts and Futures Markets

Hendrik S. Houthakker and Peter J. Williamson

in The Economics of Financial Markets

This is the first of two chapters dealing with futures contracts, and it concentrates on the defining characteristics of a futures contract, on ways in which it can be settled, on types of ... More

This is the first of two chapters dealing with futures contracts, and it concentrates on the defining characteristics of a futures contract, on ways in which it can be settled, on types of commodities and financial instruments in which futures trading is likely to be successful, and on measures of the importance of futures markets; the discussion is with respect to the USA. The exchanges on which futures contracts are traded are also explored: the history of organized markets, the role of the clearinghouses, the form of quotations, and the main market participants – hedgers, speculators, arbitrageurs and floor traders. The following chapter examines some of the theory and empirical evidence on the pricing of futures contracts, paralleling the discussion of stock and options prices in earlier chapters; it should be noted that some of the finer points in Ch. 9 may not be fully clear without the analysis of futures prices presented in Chapter 10. The first section of Ch. 9 looks at forward contracts, and the rest of the chapter is devoted to futures contracts (which are a highly standardized forwards contract) per se – with sections on the origin of futures trading, basic elements of futures contracts and the organization of futures markets. An appendix discusses the Euromarkets and the swap market.Less

Real Estate and Other Markets

Robert J. Shiller

in Macro Markets: Creating Institutions for Managing Society's Largest Economic Risks

There are other income factors, besides the aggregate national income and labour income factors discussed in Ch. 4, that contribute as much uncertainty to the incomes of individuals and organizations ... More

There are other income factors, besides the aggregate national income and labour income factors discussed in Ch. 4, that contribute as much uncertainty to the incomes of individuals and organizations as do many risks currently traded in financial markets. If those who retail insurance policies against risks of changes in values of claims on incomes or service flows are to be able to tailor their insurance to the various exposures that their different clients have to these risks, they will want to layoff in hedging markets the risks of changes in these income factors that influence them because they are providing the insurance policies. This chapter considers some of the most salient of these other markets: real estate, unincorporated business, and privately held corporations, consumer and producer price index futures, agriculture, and art and collectibles. It also presents some ideas on systematic approaches to finding other markets, including modelling the tendency for co‐movement of incomes and inferring the underlying factors, i.e. looking for the major risk factors to incomes for which new markets would be most useful.Less

FORWARD AND FUTURES PRICES OF CONTINGENT CLAIMS

Ser-Huang Poon and Richard Stapleton

in Asset Pricing in Discrete Time: A Complete Markets Approach

‘Forward and Futures Prices of Contingent Claims’ applies the multi-period rational expectations model to analyse the pricing of forward and futures contracts and derives an expression for the ... More

‘Forward and Futures Prices of Contingent Claims’ applies the multi-period rational expectations model to analyse the pricing of forward and futures contracts and derives an expression for the difference between the prices of the two, which is commonly known as the convexity adjustment. These are illustrated using an example where the asset price, the pricing kernel and the bond prices are joint lognormal variables. The authors then consider the futures and forward prices of contingent claims, such as call options. Futures prices of options can be significantly different from the forward prices of the contingent claims, especially when the options are on interest-rate related assets such as bonds or swaps. Forward prices of long-term bond can be obtained by taking appropriate expected values of future spot pries under the risk-neutral measure.Less

Paul Samuelson and Financial Economics

Robert C. Merton

in Samuelsonian Economics and the Twenty-First Century

This chapter's appraisal places models of time and uncertainty in household allocation of resources at the center of the Samuelson Contribution. It assesses Samuelson's contributions to the areas of ... More

This chapter's appraisal places models of time and uncertainty in household allocation of resources at the center of the Samuelson Contribution. It assesses Samuelson's contributions to the areas of efficient market theory and risk analysis, portfolio selection, and option and warrant pricing. Samuelson found that efficient markets do not allocate resources the way casinos do. Rather, asset prices vary randomly around an optimal path that can be discerned mathematically. The theory links spot price with future prices in order to forge a solution where spot prices are determined by optimal control theory. Samuelson's work in warrants and option pricing provides a bridge between early and later option pricing models, thanks to his insights on hedging and mathematical analysis that were incorporated into subsequent theories.Less

The Relationship between Spot and Futures CO2 Emission Allowance Prices in the EU ETS

Stefan Trück, Wolfgang Härdle, and Rafal Weron

in Emissions Trading as a Policy Instrument: Evaluation and Prospects

We investigate the relationship between spot and futures prices within the EU-ETS. We conduct an empirical study on price behavior, volatility term structure and correlations in EU Allowance (EUA) ... More

We investigate the relationship between spot and futures prices within the EU-ETS. We conduct an empirical study on price behavior, volatility term structure and correlations in EU Allowance (EUA) contracts during the pilot trading and the first Kyoto commitment period. For the pilot trading period, the market was initially in backwardation. After the news of sufficiently high allocations, both allowance prices and convenience yields approached zero, while futures contracts referring to the Kyoto commitment period were less affected by the price drop. During Phase II, we find that the market has changed from initial backwardation to contango with significant convenience yields in futures contracts. We attribute this deviation from the cost-of-carry relationship to three main factors: low interest rates in the Eurozone; market participants’ willingness to pay a premium for a hedge against rising prices in future periods, and, the increasing level of surplus allowances and banking during Phase II.Less

Are Commodity Futures Prices Barometers of the Global Economy?

Conghui Hu and Wei Xiong

in After the Flood: How the Great Recession Changed Economic Thought

This paper analyzes whether commodity futures prices traded in the United States reveal information relevant to stock prices of East Asian economies including China, Japan, Hong Kong, South Korea, ... More

This paper analyzes whether commodity futures prices traded in the United States reveal information relevant to stock prices of East Asian economies including China, Japan, Hong Kong, South Korea, and Taiwan. We find significant and positive predictive powers of overnight futures returns of copper and soybeans, albeit not crude oil, for stock prices of all these East Asian economies and across a broad range of industries after mid-2000s. Our analysis establishes commodity futures prices as barometers of global economic strength in recent years, but leaves open a deeper issue regarding whether through this informational channel noise from futures market trading can feed back to the real economy.Less

Bubbles, Food Prices, and Speculation: Evidence from the CFTC’s Daily Large Trader Data Files

Nicole M. Aulerich, Scott H. Irwin, and Philip Garcia

in The Economics of Food Price Volatility

The “Masters Hypothesis” claims that unprecedented buying pressures from new financial index investors created a massive bubble in agricultural futures prices at various times in recent years. This ... More

The “Masters Hypothesis” claims that unprecedented buying pressures from new financial index investors created a massive bubble in agricultural futures prices at various times in recent years. This chapter analyzes the market impact of financial index investment in agricultural futures markets using non-public data from the Large Trader Reporting System (LTRS) maintained by the U.S. Commodity Futures Trading Commission (CFTC). The LTRS data is superior to publicly-available data because commodity index trader (CIT) positions are available on a daily basis, positions are disaggregated by contract maturity, and positions before 2006 can be reliably estimated. The null hypothesis of no impact of aggregate CIT positions on daily returns is rejected in only 3 of the 12 markets. Point estimates of the cumulative impact of a one standard deviation increase in CIT positions on daily returns are negative and very small, averaging only about two basis points. The null hypothesis that CIT positions do not impact daily returns in a data-defined roll period is rejected in 5 of the 12 markets and estimated cumulative impacts are negative in all 12 markets; the opposite of the expected outcome if CIT rolling activity simultaneously pressures nearby prices downward and first deferred prices upward.Less

On Efficient Utilization of Egypt's Energy Resources: Oil and Natural Gas

Hanaa Kheir-El-Din

in The Egyptian Economy: Current Challenges and Future Prospects

This chapter examines the topic of energy policy in Egypt on several fronts. Section 1 examines the world energy market with reasonable estimates of future prices for oil and natural gas, such that ... More

This chapter examines the topic of energy policy in Egypt on several fronts. Section 1 examines the world energy market with reasonable estimates of future prices for oil and natural gas, such that the “most likely” scenario from the US Department of Energy's Information Administration database. Section 2 analyzes the energy sector in Egypt including historical production, consumption, and net exports of energy resources. In addition, the research tackles when and to what extent Egypt will turn into a net importer of oil, and analyzes the trend of such behavior. Derivation of a time path for natural gas resource depletion, based upon proven reserves, and a forecasted timeline of natural gas consumption until 2025 is conducted. This is based upon comparative elasticity analysis between oil and natural gas including the calculation of price elasticity, income elasticity, and energy/GDP elasticity for both resources, and the calculation of the elasticity of substitution between oil and natural gas. The analysis also includes an energy sustainability constraint (via an application of Hartwick's model) on resource extraction rates, with the objective of guaranteeing future expected energy demand, conditional upon GDP growth rate targets, which guarantee sustainable development. Energy sustainability analysis incorporates alternative energy use including solar and nuclear energy. Section 4 offers policy recommendations.Less

Pricing of Futures Contracts

Timothy A. Krause

in Commodities: Markets, Performance, and Strategies

This chapter examines the relation between futures prices relative to the spot price of the underlying asset. Basic futures pricing is characterized by the convergence of futures and spot prices ... More

This chapter examines the relation between futures prices relative to the spot price of the underlying asset. Basic futures pricing is characterized by the convergence of futures and spot prices during the delivery period just before contract expiration. However, “no arbitrage” arguments that dictate the fair value of futures contracts largely determine pricing relations before expiration. Although the cost of carry model in its various forms largely determines futures prices before expiration, the chapter presents alternative explanations. Related commodity futures complexes exhibit mean-reverting behavior, as seen in commodity spread markets and other interrelated commodities. Energy commodity futures prices can be somewhat accurately modeled as a generalized autoregressive conditional heteroskedastic (GARCH) process, although whether these models provide economically significant excess returns is uncertain.Less

From Afar: Charts and Their Analysts

Alex Preda

in Framing Finance: The Boundaries of Markets and Modern Capitalism

This chapter deals with a specific dimension of the boundaries of finance: the mediation of value judgments by securities analysts. It traces the emergence of chartists as a specific group in ... More

This chapter deals with a specific dimension of the boundaries of finance: the mediation of value judgments by securities analysts. It traces the emergence of chartists as a specific group in relation to the new kind of price data generated by the stock ticker. Occasional and unsystematic evaluation of securities had always taken place, and financial information had always been collected, more or less systematically. The new price data, however, boosted efforts to predict future prices movements and, with them, the value of securities. Some brokers left financial transactions and moved into price interpretation. They diligently began selling their intellectual product around, and so technical analysis was thus born. The chapter examines, how using memoirs, letters, journal articles, and manuals, a group of former brokers and statisticians successfully marketed price charts and technical analyses to investors and stock brokers alike. Contrary to the assumption that the growing complexity and mass of financial information required this sort of cognitive intermediation, it shows here how intermediaries created a demand for this sort of product.Less

Forwards and Futures

Tomas Björk

in Arbitrage Theory in Continuous Time

In this chapter, we provide fairly general results for forward and futures prices.

Derivatives and options

Peter Richmond, Jürgen Mimkes, and Stefan Hutzler

in Econophysics and Physical Economics

This chapter traces the origins of the use of derivatives to the era of Mesopotamian farmers and compares it to similar transactions widely used by businesses today. Mesopotamian farmers routinely ... More

This chapter traces the origins of the use of derivatives to the era of Mesopotamian farmers and compares it to similar transactions widely used by businesses today. Mesopotamian farmers routinely sold the following year's grain harvest due for delivery at the time of harvesting at a ‘future’ price, agreed today. The actual future price went up and down according to the market. Today, for a fee, an agreement is made to engage, at some point in the future, in a trade at a fixed price. The fee is the price of the so-called derivative contract that clearly should depend in some way on the price of the underlying asset. All businesses seek to reduce uncertainty in the financial state of their businesses by trying to fix the price of the underlying commodity. As a result, they are all natural buyers and sellers of derivative contracts.Less

Vegetable Oil Trade and Markets

Derek Byerlee, Walter P. Falcon, and Rosamond L. Naylor

in The Tropical Oil Crop Revolution: Food, Feed, Fuel, and Forests

Findings presented thus far are used to analyze trade and markets in vegetable oils. Particular attention is given to the dramatic liberalization of trade and the resulting surge in imports of ... More

Findings presented thus far are used to analyze trade and markets in vegetable oils. Particular attention is given to the dramatic liberalization of trade and the resulting surge in imports of oilseeds and their derivatives by the large countries in Asia. Price formation in vegetable oil markets is reviewed, with particular attention paid to the role of substitution among the various oils. Finally, future prospects are analyzed, and quantitative projections of oil and oilseeds to 2050 are provided.Less

The Temporary Equilibrium Model

Yves Balasko

in The Equilibrium Manifold: Postmodern Developments in the Theory of General Economic Equilibrium

This chapter deals with the two-period temporary equilibrium model with financial assets and arbitrary forecast functions of future prices, an approach in the tradition of Lindahl (1939) and Hicks ... More

This chapter deals with the two-period temporary equilibrium model with financial assets and arbitrary forecast functions of future prices, an approach in the tradition of Lindahl (1939) and Hicks (1946). At variance with earlier treatments of the temporary equilibrium model, future prices are included in the states of nature. In other words, economic agents forecast probability distributions of future prices. This approach provides the temporary equilibrium model with assets a reduced form that is the Arrow–Debreu model with the price-dependent preferences of Chapter 6.Less