4Futures_predict_info

4Futures_predict_info - Futures Returns: Predictability and...

Info iconThis preview shows pages 1–9. Sign up to view the full content.

View Full Document Right Arrow Icon
Futures Returns: Predictability and Information Content
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Question: is futures trading profitable? Suppose a trader continuously enters into forward contracts and holds these contracts until they expire. Will he/she make money, loose money, or come out +/- 0 on average?
Background image of page 2
Today´s agenda • Forward prices and future spot prices: the unbiased expectations hypothesis (UEH) • An application of the UEH: The covered interest rate parity as a theory of exchange rate determination
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Some market lingo: A homonymy: If the forward curve is upward-sloping , then the market is said to be in contango . If the forward curve is downward sloping , the market is said to be in backwardation. If the forward price is above the expected future spot price then the market is said to be in contango . If the forward price is below the expected future spot price then the market is said to be in normal backwardation. Today, we focus on the second question: whether the forward price is below or above the expected future spot price.
Background image of page 4
The certainty case Suppose that (we think that) the spot price does not change over time. If the market is in normal backwardation, then the forward price will rise and converge to the spot price. A long forward contract makes money. If the market is in contango, a short forward position makes money. S 0 F 0,T T Time F t,T
Background image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Uncertainty • Expected profit on a long forward position: E t ( Π T ) = E(S T – F t,T ) = E(S T ) – F t,T E(S T ) – F t,T is called the forward bias. – The forward bias must vanish over time: lim t T F t,T =S T • Is it true that F t,T = E(S T ) ? – Can risk-neutral investors profit from forward contracts? Is the forward bias predictable? – Are forward prices expected future spot prices? If so, forward markets can predict the future.
Background image of page 6
The Unbiased Expectations Hypothesis (UEH) The UEH: the expected futures spot rate is equal to the current forward rate. But, the UEH cannot be true in general! Case in point: currency markets. Suppose that x T is the future $/¥ exchange rate. Then 1/x T is the future ¥/$ exchange rate. Siegel paradox: If E(x T ) = F 0,T then E(1/x T ) > 1/F 0,T (Jensen´s inequality)
Background image of page 7

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Testing the UEH • Regression tests of the UEH are based on the following research strategy: – If E(S T ) = F 0,T then deviations between S T and F 0,T must be totally unpredictable (in an efficient market):
Background image of page 8
Image of page 9
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 10/25/2009 for the course 15 15.402 taught by Professor Bergman during the Fall '09 term at MIT.

Page1 / 26

4Futures_predict_info - Futures Returns: Predictability and...

This preview shows document pages 1 - 9. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online