Review of Futures Markets - Abstracts
Fall 2009, Volume 18 Number 2
Summer 2009, Volume 18 Number 1
Spring 2009, Volume 17 Number 4
Winter 2008-2009, Volume 17 Number 3
Fall 2008, Volume 17 Number 2
Summer 2008, Volume 17 Number 1
An online archive of earlier articles is available at http://www.rfmjournals-archive.com/
Volume 18, Issue 2 (Fall 2009)
When Does the Options Market Lead the Futures Market? Evidence from Taiwan's Emerging Derivatives Market
Scott Fung and Shih-Chuan Tsai
When does the options market lead the futures market? Using a unique setting from Taiwan's emerging derivatives markets, this study examines the interrelationship between the futures market and the options market and demonstrates that an implied volatility index from an informed options market can lead futures market returns. We construct the Taiwan Implied Volatility Index (TVIX) and find it to be a market-sentiment indicator capable of predicting index futures returns over a two-day horizon. Option-market conditions affect the informational efficiency of option prices, such that the TVIX has a greater impact on index futures returns during periods of high trading volume and low open interest. We also find that changes in the TVIX exhibit a non-linear, asymmetric effect on index futures returns. Finally, incorporating the TVIX into various trading strategies for index future contracts results in superior performance.
Cash Settlement of Lean Hog Futures Contracts Reexamined
Miguel I. Gómez, Julieta M. Frank, Eugene L. Kunda, and Philip Garcia
In 1997 the Chicago Mercantile Exchange replaced its live hog futures contract with a cash-settlement mechanism based on a Lean Hog Index. Producers and packers are concerned convergence between cash and futures prices is not occurring and that basis volatility has increased in recent years. Our results indicate that basis has widened and its variability prior to expiration has increased in the cash-settlement period. Despite some evidence that ex-ante basis risk has increased, the ability to forecast basis prior to expiration has not decreased appreciably with cash settlement. In the absence of forecasting procedures, producers and market participants have experienced additional variability in their selling prices. Hedging generally reduces the variability in cash prices, but its ability to do so has declined during the cash-settlement period due to increased basis variability.
Cospectral and Wavelet Analyses of Corn and Gasoline Futures Prices
Joseph McCarthy and Alexei G. Orlov
This research uses cospectral and wavelet methodologies to study the comovements of daily gasoline and corn futures prices, as well as the Commodity Research Bureau (CRB) index. Our findings show that there is a distinct structural break in the data series beginning in 2006, coincident with the enforcement date of the Energy Policy Act of 2005. It is also shown that prior to 2006 the relationship between corn and gasoline futures was largely driven by the increases in the overall price level, as reflected in the CRB index.
Keynes on Financial Markets: Why Didn't You Listen?
Paul Dawson, Michael A. Ellis, Mark E. Holder, and Richard J. Kent
John Maynard Keynes, the British economist, reputedly wrote or said that "Markets can stay irrational longer than you can stay solvent." Keynes had very extensive knowledge of financial markets, based on substantial personal experience. For many years he was a very active participant in a wide variety of markets, as an investor and as a speculator, both for himself and for a number of organizations for which he was involved with establishing investment policy. In this paper a number of passing remarks, obiter dicta, by Keynes on financial markets and market participants, many of which are relevant to today's markets and recent developments, are presented. Keynes's experience as an investor and speculator is briefly discussed. Finally, whether Keynes wrote the above quote is discussed.
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Volume 18, Issue 1 (Summer 2009)
Common Industry Exposure in Seemingly Unrelated Commodities
Michael T. Chng
We propose and document robust evidence of cross-market return, volatility, and volume interactions among futures contracts written seemingly unrelated commodities exposed to a common industry. On the Tokyo Commodity Exchange, we find such evidence in natural rubber (NR), aluminum (AL) and gasoline (GA) futures markets, which are complementary commodities heavily consumed by Japan's automobile industry. Our VAR results indicate that (i) for shorter dynamics, NR and GA volatility both influence AL volatility; GA volume affects NR volatility and volume; the GA market is immune to both NR and AL trading activities; (ii) for longer dynamics, AL volume affects both NR volume and GA volatility; NR volume influences GA volume. These results are robust to lag-specifications, volatility measures and are consistent with full BEKK-GARCH estimates. Further analysis using the silver contract, TOCOM and TOPIX transportation indices, shows that a commodity market factor cannot explain our result. Our results offer insights into how commodity and equity markets relate at an industry level.
Copula-Based Dynamic Hedging Strategies in Stock Index Futures: International Evidence
Yi-Hao Lai
This article develops copula-GARCH models for estimating time-varying optimal hedge ratios, enabling various dependence structures between spot and futures returns. The results show that copula-GARCH models generally outperform the DCC GARCH and the OLS static hedging for both in- and out-of-sample evaluations in terms of variance reduction, implying the importance of asymmetric dependence in dynamic hedging. The Wilcoxon signed ranks test further indicates that Gumbel copula performs well for the in-sample period, and all copulas (except Clayton, which is inferior) provides similar hedging effectiveness for the out-of-sample period in accordance with the market conditions over the full sample period.
Day-of-the-Week Effects in the U.S. and Chinese Commodity Futures Markets
Kuei-Chih Lee, Hung-Gay Fung, and Tung Liang Liao
This study uses the stochastic dominance with and without risk-free assets (SDR and SD) to examine day-of-the-week effect patterns for the commodity futures markets in the U.S. and China. The results indicate that higher returns generally appear on Monday or Friday for the U.S. market but on Monday in the Chinese markets, which confirm the presence, but different patterns, of the day-of-the-week effect in two countries. The day-of-the-week patterns in the two countries appear to be related. Simulation results generally indicate that there are trading profits to be made according to the day-of-the-week effect patterns.
A New Look at Copper Markets: A Regime-switching Model
Wing Hong Chan and Denise Young
GARCH-jump models of metal price returns, while allowing for sudden movements (jumps), apply the same specification of the jump component in both 'bear' and 'bull' markets. As a result, the more frequent but relatively small jumps that occur in both bear and bull markets dominate the characterization of the jump process. Given that large jumps, although less frequent, are still quite common in copper (and other metal) markets, this is a potential shortcoming of current models. More flexibility can be added to the modeling process by allowing for regime-switching. In this paper we specify a model that allows for switching across two separate regimes, with the possibility of different jump sizes and frequencies under each regime, along with a regime-specific GARCH process for the conditional variance. This model is applied to daily copper futures prices over the period of January 2, 1980, through the end of July 2007. The model is estimated both with and without factors such as interest and exchange rate movements entering into the specification of the state-dependent mean of the conditional jump size. In some respects, a Regime Switching GARCH-Jump Model performs well when applied to the copper returns data. The results are mixed in terms of whether or not variations of the model that allow jump sizes to be a function of interest or exchange rates offer much of an advantage over a pure time series approach to the modeling of copper returns over the past three decades.
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Volume 17, Issue 4 (Spring 2009)
New Insights into India's Single Stock Futures Markets
Mao-wei Hung and Leh-chyan So
This study investigates correlations between India's bustling single stock futures (SSFs) and its peculiar Badla mechanism. Data from the world's most active SSF market, the National Stock Exchange (NSE) of India, are used. The results indicate that both the Badla mechanism and the introduction of SSFs seem to have contributed to the higher volatility of the spot markets. Our results show that the NSE's success with SSFs can be attributed to the peculiar trading conventions of the Badla system. However, we propose that this success could come at the cost of market disability, suggesting that there is justification for strengthening market regulations.
Synthetic Currency Cross-Hedge Using Gold Futures versus Currency Forwards under a DCC-GARCH Model
Bing-Huei Lin and Yueh-Neng Lin
This study investigates whether a synthetic currency cross-hedge using gold futures is effective and beneficial than over-the-counter currency forwards. The hedge ratio is adjusted to account for changing correlations and volatilities between the returns of the assets for the hedge. Time-varying covariances are parameterized in the DCC-GARCH specification, proposed by Engle (2002). Our results show that DCC-GARCH can help reduce constant-covariance model misspecification to manage the currency price risk. The currency forwards enhance hedging effectiveness relative to the benchmark, a synthetic currency futures contract that is formed by two gold futures contracts denominated in New Taiwan dollar and U.S. dollar traded on the TAIFEX.
Price Formation and Liquidity Surrounding Large Trades in Interest Rate and Equity Index Futures
Angelo Aspris, James Richard Cummings, and Alex Frino
This paper examines the effects of the direction of trade initiation and trade size on the resiliency of financial futures markets by analyzing quote prices, bid-ask spreads, and depths. The price and liquidity reactions reveal the unexpected information content of large trades. In the market adjustment process, the size of quotes posted by liquidity providers is shown to play a more important role in futures markets than in previous research for equity markets. The liquidity cost of a large futures trade is mainly a pecuniary externality borne by other traders by impairing their continued ability to trade.
Does Spurious Mean Reversion in Basis Changes Still Exist after the Introduction of Exchange Traded Funds?
Jayaram Muthuswamy, Nivine Richie, Reuben Segara, and Robert Webb
In their seminal Journal of Finance article, Miller, Muthuswamy, and Whaley (MMW, 1994) document that the observed mean reversion of changes in the basis of cash and stock index futures prices is likely illusory. MMW use a simple time-series model to suggest that the apparent mean-reversion in the basis is a spurious artefact of nonsynchronous prices between index futures and cash markets - rather than an indication of exploitable weak-form market inefficiency. Because the MMW effect is predominantly driven by liquidity differentials between cash and futures prices, the question naturally arises as to whether one would observe the same MMW phenomenon in the behavior of the basis or difference between more actively traded exchange traded funds (ETF) and cash market prices. This study attempts to answer that question by examining the basis behavior of the Standard and Poor's Depository Receipt (SPDR) ETF traded on the American Stock Exchange. Overall, we find that the MMW phenomenon still persists strongly after the advent of exchange traded funds. Moreover, an examination of the spread or basis between cash and ETF prices and the spread or basis between futures and ETF prices shows that the apparent mean reversion in both is even more pronounced than in the basis between cash and futures prices. This demonstrates that the MMW effect is extremely robust and unlikely to go away soon.
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Volume 17, Issue 3 (Winter 2008-2009)
Microstructure Evolution in the Credit Default Swaps Market
Pavel Pinkava and Paul Dawson
The considerable turbulence observed in financial markets during 2008 has focused much attention on the microstructure of the credit default swaps market. We argue here that (i) the microstructure of this market was evolving towards an exchange-traded model even prior to the events of 2008; (ii) practitioner and regulatory reaction to the events of 2008 will accelerate this evolution; and (iii) complete on-exchange trading, currently widely dismissed as impractical, is more feasible than many commentators suggest.
A Panel Cointegration Approach to the Relation between Spot and Future Commodity Prices
Benjamas Jirasakuldech, Sean M. Snaith, and Riza Emekter
Prior empirical studies using cointegration tests of efficiency in commodity markets provide inconclusive results. This paper analyzes the relationship between commodity spot and future prices using the panel cointegration techniques developed by Pedroni (2001, 2004). The application of Pedroni's panel cointegration techniques allows for heterogeneity and differences in short-run dynamics of individual members of the panel. We examine 28 commodities classified into five groups: energy, foodstuffs and industrial, grains and oilseeds, livestocks and meats, and metals. We find that the quarterly settlement prices of commodity spot and future prices in each panel are cointegrated, supporting evidence of both weak and strong forms of the efficient market hypothesis.
Realized Volatility and Correlation in Grain Futures Markets: Testing for Spillover Effects
Jae H. Kim and Hristos Doucouliagos
Fluctuations in commodity prices are a major concern to many market participants. This paper uses realized volatility methods to calculate daily volatility and correlation estimates for three grain futures prices (corn, soybean, and wheat). The realized volatility estimates exhibit properties consistent with the stylized facts observed in earlier studies. According to daily realized correlations and regression coefficients, the spot returns from the three grain futures are positively related. The realized estimates are then used to evaluate the degree of volatility transmission across grain futures prices. The impulse response analysis is conducted by fitting the vector autoregressive model to realized volatility and correlation estimates, using the bootstrap method for statistical inference. The results indicate that rich dynamic interactions exist among the volatilities and correlations across the grain futures markets.
Auction Designs and Futures Price Behavior: Evidence from the Taiwan Futures Market
Hsiu-Chuan Lee, Cheng-Yi Chien, Yi-Fen Hsieh, and Yen-Sheng Huang
This paper analyzes the impact of the transfer from a call auction to continuous trading on futures price behavior. Using tick by tick data from the Taiwan Futures Exchange (TAIFEX), the empirical results show that the reduction in the costs of information asymmetry and an improvement in price efficiency are achieved at the expense of the decrease in market liquidity when the TAIFEX transfers from a call auction to continuous trading. Additionally, this paper finds that the relative rate of price discovery for heavily traded futures contracts increases following the transfer to continuous trading, implying that continuous trading is more suitable for heavily traded futures contracts. Overall, the empirical results indicate that auction designs have impact on futures price behavior.
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Volume 17, Issue 2 (Fall 2008)
Are the European Carbon Markets Efficient?
George Daskalakis and Raphael N. Markellos
This paper examines the efficiency of the European market for carbon dioxide emission allowances. To this end, spot and futures market data are analyzed from Powernext, Nord Pool and ECX, the three main exchanges under the European Union Emission Trading Scheme (EU ETS). The methodology employs econometric testing procedures and trading strategies based on technical analysis rules and naive forecasts. The empirical results suggest that the behavior of the markets under consideration is not consistent with weak form efficiency. This could be due to the immaturity of the EU ETS and to the restrictions imposed on short-selling and on "banking" of emission allowances. The results are particularly important for emission-intensive firms, policy makers, and risk managers and for active or passive investors in the emerging class of energy and carbon hedge funds.
Performance, Bias, and Efficiency of Foreign Exchange Correlation Forecasts
Stefano Mazzotta
This paper evaluates the performance, bias, and the efficiency of option-implied and return-based correlation measures using 12 years of daily data on foreign exchange and over-the-counter (OTC) currency option. The sample includes five years of rates for the Polish zloty and the Czech koruna with respect to the euro and the U.S. dollar. The results show that implied correlation is a good predictor of realized correlation and is, generally, unbiased and efficient.
Option Prices as Predictors of Aggregate Stock Returns
R. Brian Balyeat and Bilal Erturk
The relative prices of S&P 500 index call and put options convey information regarding the future return of the S&P 500 index realized over the life of the options. When call options are relatively more expensive than put options, the index earns higher returns. Specifically, the natural log of the ratio of the out-of-the-money call price to the equally out-of-the-money put price at differing moneyness levels and maturities is positively related to the return of the index realized over the life of the options. This predictability is robust to controls for the cost of carry, past returns, implied volatility, and upper moments of the underlying. Furthermore, the results do not appear to be driven by the sign of the log ratio. Portfolios of the underlying, formed when the log ratio of the options prices is positive (when call options are more expensive), statistically outperform portfolios similarly formed when the log ratio is negative (when put options are more expensive). A simple investment strategy of increasing the S&P 500 weight in a portfolio when the ln(c/p) signal is positive and decreasing the weight when the value of the signal is negative significantly outperforms a static portfolio allocation.
The Non-Convergence of the VIX Futures at Expiration
Ivelina Pavlova and Robert T. Daigler
We examine the issue of non-convergence of the VIX futures to the cash VIX, the associated expiration day effects, and their sources. Significant disparities are found between the value of the cash VIX and the VIX futures at settlement of the contract. The reasons for this difference include the settlement procedure of the exchange and the underlying S&P 500 options order imbalances at settlement, the latter affected by traders unwinding arbitrage positions. We propose an alternative settlement procedure that mitigates these problems.
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Volume 17, Issue 1 (Summer 2008)
Hedging "Event" Risk
Philip McBride Johnson
On May 1, 2008, the same day when Soviet tanks used to rumble through
Red Square, the Commodity Futures Trading Commission announced that
it will consider whether instruments that are related to the outcome of events such as elections, sporting contests or population growth should be blessed with its regulatory approval or should be branded as gaming contracts. Of course, nearly all of the existing "futures contracts" and "commodity options" within the CFTC's remit involve patronage by large numbers of speculators, so the mere assumption of a foreign risk by people who could readily avoid it cannot be, in itself, a disqualification. Presumably, the outcome will hinge on whether any economic benefit inures from these instruments other than the thrill of the wager.
Discussion Regarding the Commentary on Hedging "Event" Risk
Kathryn M. Trkla
The CFTC issued its Concept Release to solicit comment on the appropriate regulatory treatment of event contracts under the Commodity Exchange Act (CEA). [73 FR 25669 (May 7, 2008)] As a threshold matter, if the contract is a commodity future or commodity option, it is covered by the CEA and subject to the CFTC's jurisdiction, with some exceptions. As the Commission notes, event contracts "can be designed to exhibit the attributes of either options or futures contracts." [73 FR 25670] From a layman's perspective, the obvious question is how, possibly, could events be considered commodities. As explained in the Concept Release and the Commentary by Philip McBride Johnson in this issue, the CEA contains a broad definition of "commodity" that covers events. Thus, events can be (and already are) the subject of CFTC-regulated futures or options trading. In the amendments to the CEA in 2000, Congress even included within the new definition of "excluded commodity" - a subset of the broader commodity definition - events where the occurrence of the event is "associated with a financial, commercial, or economic consequence" and is "beyond the control of the parties to the relevant contract." [7 U.S.C. §1a(13)]
Public Information, Price Volatility, and Trading Volume in U.S. Bond Markets
Mardi Dungey, Alex Frino, and Michael D. McKenzie (G12, G14)
Prices in bond markets have been noted as moving extremely rapidly following macroeconomic news announcements - with a delayed increase in trading volume. New data allows us to demonstrate that the previously unexplained dichotomy between rapid price and sluggish volume movement in the U.S. Treasury's cash market originates with rapid price and volume change in the Treasury futures market. Consistent with research in other markets, the Treasury futures lead price discovery in the cash market.
Value-at-Risk Ananlysis for KOSPI 200 Index Futures: Evidence from Long Memory Volatility Models with a Skewed Student-t Distribution
Sang Hoon Kang and Seong-Min Yoon (C32, C52, G11)
We computed daily Value-at-Risk (VaR) for KOSPI 200 Index futures returns using two long memory volatility models (FIGARCH and FIAPARCH) based on the normal, Student-t, and skewed Student-t innovation distributions. We considered asymmetric long memory in the conditional variance and asymmetric fat-tailed distributions. Both the in-sample and out-of-sample VaR analyses indicated that the FIGARCH and FIAPARCH models with the skewed Student-t distribution innovation provide more accurate volatility forecasting for KOSPI 200 Index futures than do the models with the normal and Student-t distribution innovations. These VaR analyses provide an optimal margin level of risk in the KOSPI 200 Index futures market.
Volatility Estimation and the Performance of Multifactor Term Structure Models for Pricing and Hedging Euribor Options
I-Doun Kuo, Cheng-Hsiang Lin, and Min-Teh Yu (G12, G13)
This paper provides an empirical comparison of several competing term structure models in pricing and hedging of Euribor options with alternative approaches to volatility estimation using data of options prices or their underlying futures prices. The empirical results show that models using the option prices perform better than those using the futures prices in predicting Euribor option prices. In particular, when volatility is assumed to be time-varying, a more accurate prediction of option prices is obtained. When the volatility is further assumed to be time-varying and time-homogenous, it reduces the moneyness and maturity biases found in the literature. There is no clear pattern showing that one term structure model consistently predicts better than others under alternative approaches of volatility estimation. In contrast to prediction results, hedging results show that the stability of volatility is critical in ensuring hedging performance. The two-factor models produce better hedging performance than the one- and three-factor models in most cases. Finally, this study demonstrates that choosing an appropriate method of volatility estimation is more important than specifying the term structure model for pricing and hedging interest rate derivatives.
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