Showing papers on "Spot contract published in 1985"

Using Survey Data to Test Some Standard Propositions Regarding Exchange Rate Expectations

Abstract: Survey data provide a measure of exchange rate expectations that is superior to the commonly-used forward exchange rate in the respect that it does notinclude a risk premium. We use survey data and the technique of bootstrapping to test a number of propositions of interest. We are able to reject static or "randomwalk" expectations for both nominal and real exchange rates. Expected depreciation is large in magnitude. There is even statistically significant unconditional bias: during the 1981-85 "strong dollar period" the market persistently over estimated depreciation of the dollar. Expected depreciation is also variable, contrary to some recent claims. The expected future spot rate can be viewed as inelastic with respect to the contemporaneous spot rate, in that it also puts weight on other variables: the lagged expected spot rate (as in adaptive expectations), the lagged actual spot rate (distributed lag expectations), or a long-run equilibrium rate (regressive expectations). In one irnportant case, the relatively low weight that investors' expectations put on the contemporaneous spot rate constitutes a statistical rejection of rational expectations: we find that prediction errors are correlated with expected depreciation, so that investors would do better if they always reduced fractionally the magnitude of expected depreciation. This is the same result found by Bilson, Fama, and many others, except that it can no longer be attributed to a risk premium.

Using Survey Data to Test Standard Propositions Regarding Exchange Rate Expectations

Abstract: Survey data provide a measure of exchange rate expectations superior to the forward rate in that no risk premium interferes. We estimate extrapolative, adaptive, and regressive models of expectations. Static or "random walk" expectations and bandwagon expectations are rejected: current appreciation generates the expectation of future depreciation because variables other than the contemporaneous spot rate receive weight. In comparing expectations to the process governing the spot rate, we find statistically significant bias. No variable is as ubiquitous in international financial theory and yet as elusive empirically as investors' expectations regarding exchange rates. In the past, expectations have been modeled in an ad hoc way, often by using the forward exchange rate. There is, however, a serious problem with using the forward discount as the measure of the expected change in the exchange rate, in that the two may not be equal. The gap that may separate the forward discount and expected depreciation is generally interpreted as a risk premium. Most of the large empirical literature testing the unbiasedness of the forward exchange rate, for example, has found it necessary either arbitrarily to assume away the existence of the risk premium, if the aim

Returns to Speculators and the Theory of Normal Backwardation

Abstract: A nonparametric statistical procedure is employed to examine the returns to speculators in wheat, corn, and soybeans futures markets. We find that the theory of normal backwardation is supported. Moreover, the presence of the risk premiums to speculators tends to be more prominent in recent years than in earlier years. We also find that large wheat speculators as a whole possessed some superior forecasting ability. The evidence is inconsistent with the hypothesis that commodity futures prices are unbiased estimates of the corresponding future spot prices. THE CLASSIC ECONOMIC RATIONALE for futures markets is that they facilitate hedging. That is, futures markets allow those who deal in commodities to obtain contracts through which the risk of price changes can be transferred to those who are willing to assume it. A side benefit of the market is that a publicly known, uniform future value for a commodity is created. Therefore, all commodity market participants can make production, storage, and processing decisions by looking at the pattern of futures price, even if they don't take positions in the futures market. Many believe that the current price of a futures contract equals the market consensus expectation of the spot price on the delivery date.' Keynes [10], however, in his theory of normal backwardation, suggests that it is unlikely that the above two functions can be fulfilled simultaneously. He argues that hedgers use the futures market to avoid risks, and that they pay a significant premium to speculators for this insurance. He concludes implicitly that the futures price is an unreliable estimate of the spot price prevailing on the date of expiration of the futures contract. Keynes' conclusion is based upon the argument that the long (short) speculator realizes the premium by refusing to purchase a contract from the short (long) hedger except at a price below (above) that which the futures price is expected to approach.2 Over the years, various studies have sought to confirm the existence of such a risk premium to speculators in the

Chapter 19 Empirical studies of exchange rates: Price behavior, rate determination and market efficiency

Abstract: Publisher Summary This chapter provides an overview of empirical results concerning recent exchange rate behavior. Alternative valuation measures, time series, and distributional properties have been covered in the chapter, along with estimates of transaction costs in the foreign exchange market. The chapter reviews empirical tests of specific models of exchange rate determination. It tests a particular model of exchange rate determination to forecast exchange rates or to examine the effect of other economic policies on exchange rates and vice versa. The chapter discusses the simple monetary approach, where exchange rates are determined by the relative demand for two moneys, and then proceeds to a portfolio balance approach that introduces bonds. It presents tests of foreign exchange market efficiency. Finally, the chapter provides an overview of efficient market theory, a review of evidence on the efficiency of markets in removing risk-free opportunities, and the evidence of the efficiency of markets in removing risky profit opportunities. It includes the evidence on the relationship between the forward rate and future spot rate.

Evaluation of Spot Price Based Electricity Rates

Abstract: It is necessary to be able to evaluate the cost of providing electric service on a hour by hour basis in order to effectively market electric energy in a fashion which meets both the utility's and its customer's needs; i. e. to offer appropriate rates, contracts, and load management options to the customers. This paper provides a methodology which uses the theory of spot prices to evaluate the variable costs of electric energy on an hourly basis. The methodology decomposes variable costs in components corresponding to generation fuel and maintenance, T and D network losses and maintenance, and generation and network quality of supply components arising from unserved energy caused by shortages of generation and network capacity. The methodology provides a choice between four different methods of revenue reconciliation to cover the capital and fixed costs of generation and the T and D network. Planning studies can be done using the methodology without developing large new computer programs. A numeric example is presented which exhibits large price variations depending on random weather and generator outages

Forward contracts or international buffer stocks? a study of their relative efficiencies in stabilising commodity export earnings*

Abstract: The commodities 'debate' of the last decade has not been very successful in creating new international agreements, but it has led to many advances in the economic theory of stabilisation. The early work, such as that of Massell (I969), assumes that complete stabilisation of price is the objective and uses the Marshallian measures of surplus to suggest that producers would gain and consumers would lose from price-stability. The later work, such as that of Newbery and Stiglitz (I98I), assumes that complete stabilisation of prices is neither feasible nor desirable. They show that a reduction in the dispersion of prices is likely to leave producers with lower average earnings, while having little significant impact on consumers. The question from the producers' view-point is whether the risk-benefits are sufficient to offset this loss of earnings. An alternative to collective action by producers would be for each of them individually to make forward contracts. This strategy will tend to stabilise earnings mainly to the extent that the contract price fluctuates less from year to year than the actual or 'spot' price. Since forward prices are likely to be lower than eventual spot prices, such forward contracting also leads to lower average earnings.

Inventories as an Asset: The Volatility of Copper Prices

Abstract: The spot price of copper metal is known to be extremely volatile. From 1958 to 1980, the mean monthly average price was $0.49 per pound (in constant 1967 dollars), while the standard deviation of month-to-month changes in the real price was $0.06. Claims to copper inventories are traded on the London Metal Exchange (LME), a competitive world asset market. This paper empirically investigates the dynamics of copper spot prices on the LME, focusing on the rate of return to holding copper metal and on the implications of inventory stockouts for this rate of return. We make one major departure from the standard economic theory of exhaustible resources.2 Instead of assuming constant short-run marginal cost (SRMC), we incorporate rising SRMC of extraction into the model.3 This technological assumption provides an economic motive for production smoothing by holding inventories. Equilibrium inventory holdings ameliorates rising SRMC by moving extraction to low SRMC time periods. We show that this amelioration is imperfect because of inventory stockouts. When stockouts can occur, the spot price of a resource reflects transient shocks to its scarcity value as well as permanent shifts. More specifically, the economic motive for inventory holding affects the equilibrium price dynamics of exhaustible resources in two ways. First, as long as positive inventories are being held, their holders should earn the competitive rate of return. Thus, the price of extracted resource should rise at the rate of interest in expected value. This result differs from most recent theoretical studies of exhaustible resources, which conclude that price minus marginal extraction cost should rise at the rate of

Nominal Contracting and Price Flexibility in Product Markets

Abstract: The search for microeconomic foundations of non-Walrasian outcomes in labor and product markets has spawned many studies of contracting. This paper emphasizes the role of contracts for market equilibrium -- for many raw materials and basic industrial commodities -- in which long-term contractual arrangements and spot markets coexist. Our principal goals are two -- (i) to explain the existence of contracts and the equilibrium fraction of trades carried out under contract, and (ii) to consider the impact of demand and supply shocks on spot prices when market trades also take place through long-term contracts. We find that the relative importance of contracting depends on, inter alia, the variance of the spot price and the sources of underlying fluctuations. Consistent with the findings of previous macroeconomic studies, we find that contracting and price rigidity are more likely the more important demand shocks are relative to supply shocks. We adapt our static model of contract price and quantity determination to discuss the adjustment of contract prices. Finally, we discuss three important applications of our multiple-price modeling structure -- to (i) analyses of the effects of changes in vertical market structure on market equilibrium in commodity markets (with specific reference to petroleum and copper), (ii) models of the optimal degree of contract indexation,and (iii) aggregate studies of "sticky prices" in macroeconomics.

An Analysis of the Stabilizing and Welfare Effects of Intervention in Spot and Futures Markets

Abstract: This paper analyzes the effects of three alternative rules on the long-run distributions of both the spot and futures prices ina single commodity market, in which the key behavioral relationships are derived from the optimizing behavior of producers and speculators.The rules considered include: (i) leaning against the wind in the spot market; (ii) utility maximizing speculative behavior by the stabilization authority in the futures market; (iii) leaning against the wind in the futures market. Since the underlying model is sufficiently complex to preclude analytical solutions, the analysis makes extensive use of simulation methods. As a general proposition we find that intervention in the futures market is not as effective in stabilizing either the spot price of the futures price as is intervention in the spot market. Indeed, Rule (iii), while stabilizing the futures price may actually destabilize the spot price. Furthermore, the analogous type of rule undertaken in the spot market will always stabilize the futures price to a greater degree than it does the spot price. The welfare implications of these rules are also discussed. Our analysis shows how these can generate rather different distributions of welfare gains, including the overall benefits.

Sequential Hedging

Abstract: This paper addresses a problem faced by the producer of a commodity for which futures are traded. The producer wishes to reduce his exposure to the random fluctuations in spot prices; however, the futures markets extend out for fewer time periods than the revenue stream that he wants to hedge. The main result of the paper is that under certain conditions on the relationship between the futures prices and past spot prices, it is still possible to hedge perfectly; in other words, there exists a sequence of futures positions that entirely eliminates the risk in the present value of the producer's revenues. Under those conditions-which are necessary as well as sufficient-the paper shows explicitly the futures positions that achieve the exact hedge.

An Analysis of the Stabilizing and Welfare Effects of Intervention in Spot and Futures Markets

Abstract: This paper analyzes the effects of three alternative rules on the long-run distributions of both the spot and futures prices ina single commodity market, in which the key behavioral relationships are derived from the optimizing behavior of producers and speculators.The rules considered include: (i) leaning against the wind in the spot market; (ii) utility maximizing speculative behavior by the stabilization authority in the futures market; (iii) leaning against the wind in the futures market. Since the underlying model is sufficiently complex to preclude analytical solutions, the analysis makes extensive use of simulation methods. As a general proposition we find that intervention in the futures market is not as effective in stabilizing either the spot price of the futures price as is intervention in the spot market. Indeed, Rule (iii), while stabilizing the futures price may actually destabilize the spot price. Furthermore, the analogous type of rule undertaken in the spot market will always stabilize the futures price to a greater degree than it does the spot price. The welfare implications of these rules are also discussed. Our analysis shows how these can generate rather different distributions of welfare gains, including the overall benefits.

Nominal Contracting and Price Flexibility in Product Markets

Abstract: The search for microeconomic foundations of non-Walrasian outcomes in labor and product markets has spawned many studies of contracting. This paper emphasizes the role of contracts for market equilibrium -- for many raw materials and basic industrial commodities -- in which long-term contractual arrangements and spot markets coexist. Our principal goals are two -- (i) to explain the existence of contracts and the equilibrium fraction of trades carried out under contract, and (ii) to consider the impact of demand and supply shocks on spot prices when market trades also take place through long-term contracts. We find that the relative importance of contracting depends on, inter alia, the variance of the spot price and the sources of underlying fluctuations. Consistent with the findings of previous macroeconomic studies, we find that contracting and price rigidity are more likely the more important demand shocks are relative to supply shocks. We adapt our static model of contract price and quantity determination to discuss the adjustment of contract prices. Finally, we discuss three important applications of our multiple-price modeling structure -- to (i) analyses of the effects of changes in vertical market structure on market equilibrium in commodity markets (with specific reference to petroleum and copper), (ii) models of the optimal degree of contract indexation,and (iii) aggregate studies of "sticky prices" in macroeconomics.