scispace - formally typeset
Search or ask a question

Showing papers on "Spot contract published in 1986"


Journal ArticleDOI
TL;DR: In this article, the authors argue that if the current spot price equals the true expectation of the future spot price, the futures market cannot provide a better forecast than the realized spot price.
Abstract: Futures markets are often described as having two important social functions. First, they facilitate the transfer of commodity price risk, and, second, they provide forecasts of commodity prices. The evidence that futures markets transfer price risk is irrefutable. However, there is some debate about the markets' forecasting ability. In particular, forecasts based on the current spot price are often as good as those based on the futures price. Some economists cite a failure to detect superior forecast power in futures prices as evidence of market inefficiency (see, e.g., Leuthold 1974; and Martin and Garcia 1981). There are at least two other explanations. First, there may be nothing for the futures market to forecast. If the current spot price equals the true expectation of the future spot price, the futures market cannot provide a better forecast. Second, a superior futures market forecast may be obscured by the unexpected component of the realized spot price. The true expectation of the future spot price is unobservable; one must approximate this expectation with the actual future spot price.

126 citations


Journal ArticleDOI
TL;DR: In this paper, the authors examined the effect of nonsynchronous prices and transaction costs on the usual option market efficiency tests and found that the early exercise boundary tests are sensitive to transaction costs but are not very sensitive to simultaneity of the option price and the underlying spot price.
Abstract: Based on a new options transactions data base from the Philadelphia Stock Exchange Foreign Currency Options Market, this paper examines the importance of the effect of nonsynchronous prices and transaction costs on the usual option market efficiency tests. The tests conducted are based on the transaction cost adjusted early exercise and put-call parity pricing boundaries applicable to the American foreign currency options market. The test results show that the put-call parity boundary tests are sensitive to both nonsynchronous prices and transaction costs. The early exercise boundary tests are sensitive to transaction costs but are not very sensitive to simultaneity of the option price and the underlying spot price. Under the no-transaction costs scenario, a large number of early exercise boundary violations is found even when simultaneous spot and option prices are used. These violations disappear when actual transaction costs are taken into account.

81 citations


Posted Content
TL;DR: The authors used survey data and the technique of bootstrapping to test a number of propositions of interest, such as 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 distributed lag expectations, or a long-run equilibrium rate (regressive 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.

71 citations


Journal ArticleDOI
TL;DR: In this article, the authors present a valuation model for the wild card option and computes estimates of the value of that option, as well as rules for its optimal exercise, based on Monte Carlo simulations.
Abstract: The Chicago Board of Trade Treasury Bond Futures Contract allows the short position several delivery options as to when and with which bond the contract will be settled. The timing option allows the short position to choose any business day in the delivery month to make delivery. In addition, the contract settlement price is locked in at 2:00 P.M. when the futures market closes, despite the facts that the short position need not declare an intent to settle the contract until 8:00 P.M. and that trading in Treasury bonds can occur all day in dealer markets. If bond prices change significantly between 2:00 and 8:00 P.M., the short has the option of settling the contract at a favorable 2:00 P.M. price. This phenomenon, which recurs on every trading day of the delivery month, creates a sequence of 6-hour put options for the short position which has been dubbed the "wild card option." This paper presents a valuation model for the wild card option and computes estimates of the value of that option, as well as rules for its optimal exercise. THE TREASURY BOND FUTURES contract on the Chicago Board of Trade gives several delivery options to the short position. The quality option, which allows the short to deliver any of several eligible delivery bonds, has already been studied fairly extensively. Because many bonds are eligible to be delivered against the futures contract, and the conversion factors used to adjust for the bond actually delivered do not perfectly reflect relative price differences, the short-side trader will choose to deliver the "cheapest" eligible bond. Kilcollin [71 presents a discussion and analysis of conversion factors and their effects on the optimal delivery bond. Gay and Manaster [4] present a theoretical valuation model for the quality option when two classes of commodities with uncertain end-of-period spot prices may be delivered. Garbade and Silber [3] provide a similar analysis and estimate parameters of the valuation formula for a variety of agricultural commodity futures. Kane and Marcus [6] have used Monte Carlo simulations to value the quality option in the Treasury bond futures market. In contrast, the various timing options embedded in the delivery process have received comparatively little attention. One of the most important of these is the so-called wild card option. The wild card option arises because the futures market closes each trading day at 2 P.M. (Central Standard Time), which locks in the futures settlement price for the rest of the day, while the short trader has until 8 P.M. of each trading day in the delivery month to declare an intent to deliver

45 citations


Journal ArticleDOI
TL;DR: The authors formalizes the risk premium theory by assuming that there are well-funded risk neutral investors and shows that risk premia cannot explain backwardation under their assumptions, instead, backwardations arise because of interactions between equilibrium in the commodities exchange, both in spot and futures trading, and the production, consumption and storage decisions taken on the real side of the economy.
Abstract: J.M. Keynes first introduced the theory of normal backwardation in futures markets. In the language of (British) commodities markets, a backwardation is an excess of the spot price over futures prices. As is well-known, Keynes suggested that this might be explained as a risk premium. Less well known is that Keynes actually proposed two distinct theories of backwardation. Of these two theories of backwardation, the latter has recently received much attention. The purpose of this paper is to formalize Keynes' first theory, his liquid stocks theory, with an eye to its eventual empirical test. We follow the recent formalizations of the risk premium theory by assuming the existence of perfectly competitive asset markets. To emphasize the differences between the two theories, however, we assume that there are well-funded risk neutral investors. Thus, risk premia cannot explain backwardation under our assumptions. Instead, backwardations arise because of interactions between equilibrium in the commodities exchange, both in spot and futures trading, and the production, consumption and storage decisions taken on the real side of the economy.

40 citations


Journal ArticleDOI
TL;DR: In this article, the Law of One Price (LOP) holds in the long and short run for commodities traded in orgnized markets, and the long-run LOP holds better for future prices than for spot prices.

38 citations


Journal ArticleDOI
TL;DR: The Value Line Composite Index (VLCI) is an equally weighted geometric average index of nearly 1700 stocks as mentioned in this paper, and the VLCI futures market has existed since 1982 and the options market was established in 1985.
Abstract: This paper considers the problems peculiar to the Value Line Index, because of its use of geometric averaging, as regards the pricing of options and futures on that index. The Value Line Composite Index (VLCI) is an equally weighted geometric average index of nearly 1700 stocks. The VLCI futures market has existed since 1982 while the VLCI options market was established in 1985. This paper provides valuation formulas and analyzes the economic properties of these contracts. Because of the geometric averaging in the VLCI, its contingent claims have special properties. For example, the futures price may fall short of the spot price and the value of a VLCI call option may decline when the volatility of the index is increased. VLCI futures are shown to provide a direct means for duplicating an equally weighted portfolio of the underlying stocks. THE VALUE LINE COMPOSITE Index (VLCI) is an unweighted geometric average of stock prices expressed in index form. The index on June 30, 1961, was set at 100, and subsequent values are compared against it. Futures contracts on the VLCI are traded on the Kansas City Board of Trade (KCBT). They were the first stock index futures to be traded in the United States, starting on February 24, 1982. Unlike commodity futures contracts, no delivery ever takes place. Instead, any open contracts on expiration day are settled in cash according to the actual VLCI value.1 More recent market innovations are options on the VLCI that have been traded on the Philadelphia Stock Exchange (PSE) since January

30 citations


ReportDOI
TL;DR: In this paper, the authors examined the risk allocation effects of alternative types of contracts used to set the price of a good to be delivered in the future, and derived and interpreted a general condition determining which contract form would be preferred when the seller and/or the buyer is risk averse.
Abstract: Thi spaper is concerned with the risk-allocation effects of alternative types of contracts used to set the price of a good tobe delivered in the future. Under a fixed price contract, the price is specified in advance. Under a spot price contract, the price is the price prevailing in the spot market at the time of delivery.These contract forms are examined in the context of a market in which sellers have uncertain production costs and buyers have uncertain valuations. The paper derives and interprets a general condition determining which contract form would be preferred when the seller and/or the buyer is risk averse. In addition, an example is provided in which a spot price contract with a floor price is superior both to a "pure" spot price contract and a fixed price contract.

24 citations


Posted Content
TL;DR: The authors tested the martingale hypothesis for daily and weekly rates of change of futures prices for five currencies and found some evidence against the null hypothesis for each currency with daily data, but only for one currency.
Abstract: The martingale hypothesis for daily and weekly rates of change of futures prices for five currencies is tested in this paper. With daily data, we find some evidence against the null hypothesis for each currency. Although institutionally imposed limits on daily price changes were binding fairly often in the earlier years of the sample, the results are not substantially different when data affected by limit moves are removed. Trading day effects in foreign currency futures and spot prices introduce complicated day of the week patterns in futures price. For this reason, we retest the martingale hypothesis with weekly data and reject the null hypothesis for only one currency. For this currency, one interpretation of the evidence is that a time-varying risk premium exists.

8 citations


Posted Content
TL;DR: In this paper, the authors examined the risk allocation effects of alternative types of contracts used to set the price of a good to be delivered in the future, and derived and interpreted a general condition determining which contract form would be preferred when the seller and/or the buyer is risk averse.
Abstract: Thi spaper is concerned with the risk-allocation effects of alternative types of contracts used to set the price of a good tobe delivered in the future. Under a fixed price contract, the price is specified in advance. Under a spot price contract, the price is the price prevailing in the spot market at the time of delivery.These contract forms are examined in the context of a market in which sellers have uncertain production costs and buyers have uncertain valuations. The paper derives and interprets a general condition determining which contract form would be preferred when the seller and/or the buyer is risk averse. In addition, an example is provided in which a spot price contract with a floor price is superior both to a "pure" spot price contract and a fixed price contract.

7 citations


Journal ArticleDOI
TL;DR: In this paper, the applicability of such a tariff to domestic and industrial sectors in Hong Kong, and possible effects on the system load curve are discussed, and a consumer survey has been carried out to gauge reaction to such a scheme; the results show a wide degree of support for the idea in the domestic sector.

Journal ArticleDOI
TL;DR: In this paper, the authors examined the hypothesis that the spot exchange rate follows a random walk and that the exoected value of the future spot rate is the current forward rate.
Abstract: This paper studies the foreign exchange market of Singapore. It examines the hypotheses that the spot exchange rate follows a random walk and that the exoected value of the future spot rate is the current forward rate. Using various powerful tests that have been developed recently in the economietric literature, we reject the two hypotheses convincingly.


Posted Content
TL;DR: In this paper, the authors test the martingale hypothesis for daily and weekly rates of change of futures prices for five currencies and reject the null hypothesis for only one currency for a time-varying risk premium.
Abstract: This paper tests the martingale hypothesis for daily and weekly rates of change of futures prices for five currencies. Daily data suggests evidence against the null for each currency. Trading day effects in foreign currency futures and spot prices introduce complicated day of the week patterns in futures prices. For this reason, we retest the martingale hypothesis using weekly data and reject the null for only one currency. For this currency, one interpretation is that of a time-varying risk premium.

Journal ArticleDOI
TL;DR: The authors reviewed the pitfalls and the merits of existing approaches to forecasting foreign exchange rates and introduced a new element in the forecasting model: the stability of predictors, and found that stability variables do improve the forecasting ability of an econometrically based model.