Showing papers on "Spot contract published in 1996"

Pricing the Risks of Default

Abstract: This paper models default risk as composed of arrival and magnitude risks. In our model the two default components are explicitly priced as if they were traded in the futures market and the spot price of risky debt is derived as a consequence. We develop estimation strategies to evaluate the magnitude risks which are then employed to construct implicit prices of pure arrival risk contingent securities. The latter prices are used to estimate the structure of arrival risks. The models are estimated on monthly data for rates on certificates of deposit offered by institutions in the Savings and Loan Industry, during the 1987-1991 period. Empirical results support market expectations of lower likelihoods of default after 1989. This paper was presented at the Wharton Financial Institutions Center's conference on Risk Management in Banking, October 13-15, 1996.

Is There a Term Structure of Futures Volatilities? Reevaluating the Samuelson Hypothesis

Abstract: The Samuelson hypothesis implies that the volatility of futures price changes increases as a contract's delivery date nears. In markets where the Samuelson hypothesis holds, accurate valuation of options and related derivatives on futures requires that a term structure of futures volatilities be estimated. We develop a framework for predicting those markets where the hypothesis should be expected to hold. In contrast to a prominent reinterpretation of the hypothesis, we show that clustering of information flows near the delivery date is not necessary. We show instead that the hypothesis will be supported in markets where spot price changes contain a predictable temporary component, and we argue that this condition is much more likely to be supported in markets for real assets than for financial assets. Finally, we provide empirical evidence consistent with our predictions.

Robust tests of forward exchange market efficiency with empirical evidence from the 1920s

Abstract: SUMMARY This paper provides a robust statistical approach to testing the unbiasedness hypothesis in forward exchange market efficiency studies. The methods we use allow us to work explicitly with levels rather than differenced data. They are statistically robust to data distributions with heavy tails, and they can be applied to data sets where the frequency of observation and the futures maturity do not coincide. In addition, our methods allow for stochastic trend non-stationarity and general forms of serial dependence. The methods are applied to daily data of spot exchange rates and forward exchange rates during the 1920s, which marked the first episode of a broadly general floating exchange rate system. The tail behaviour of the data is analysed using an adaptive data-based method for estimating the tail slope of the density. The results confirm the need for the use of robust regression methods. We find cointegration between the forward rate and spot rate for the four currencies we consider (the Belgian and French francs, the Italian lira and the US dollar, all measured against the British pound), we find support for a stationary risk premium in the case of the Belgian franc, the Italian lira and the US dollar, and we find support for the simple market efficiency hypothesis (where the forward rate is an unbiased predictor of the future spot rate and there is a zero mean risk premium) in the case of the US dollar.

Informed Traders, Intervention and Price Leadership: A Deeper View of the Microstructure of the Foreign Exchange Market

Abstract: This paper identifies price leadership patterns in foreign exchange trading, with a focus on central bank intervention as an informational trigger for leadership positioning. Granger causality tests applied to DM/US$ spot rate quotes reveal Deutsche Bank as a price leader up to 60 minutes prior to Bundesbank interventionary reports. By the minus 25-minute mark, interbank quote adjustments become two-way Granger-causal. These results suggest that central bank activity is revealed in stages: first to the price leader, then to competitors and lastly to the general public.

Foreign exchange market bid—ask spreads and the market price of social unrest

Abstract: Time-series evidence yields estimates of the increase in the spread on the South African rand on days when riots, demonstrations, armed attacks, and related deaths occur in South Africa. The cross-section evidence demonstrates how spreads vary across thirty-six industrial and developing countries as spot rate volatility and country risk vary. Both the changes in the spread over time for particular countries and the changes in the spread across the countries at a particular time appear to be significantly related to countries' risk differences and exchange-rate volatility. Copyright 1996 by Royal Economic Society.

Spreads and the market price of social unrest

Abstract: Time-series evidence yields estimates of the increase in the spread on the South African rand on days when riots, demonstrations, armed attacks, and related deaths occur in South Africa. The cross-section evidence demonstrates how spreads vary across 36 industrial and developing countries as spot rate volatility and country risk vary. Both the changes in the spread over time for particular countries and the changes in the spread across the countries at a particular time appear to be significantly related to countries' risk differences and exchange-rate volatility.

Time-Varying Risk Premia in the Foreign Currency Futures Basis

Abstract: Significant time-varying risk premia exist in the foreign currency futures basis, and these risk premia are meaningfully correlated with common macroeconomic risk factors from equity and bond markets. The stock index dividend yield and the bond default and term spreads in the U.S. markets help forecast the risk premium component of the foreign currency futures basis. The specific source of risk matters, but the relationships are robust across currencies. The currency futures basis is positively associated with the dividend yield and negatively associated with the spread variables. These correlations cannot be attributed to the expected spot price change component of the currency futures basis, thus establishing the presence of a time-varying risk premium component in the currency futures basis.(This abstract was borrowed from another version of this item.)

The Electricity Contract Market

Abstract: In England and Wales, wholesale electricity is sold in a spot market partly covered by long-term contracts which hedge the spot price. Two dominant conventional generators can raise spot prices to undesirable levels, which is profitable in the absence of contracts. If fully hedged, however, the generators lose their incentive to raise prices above marginal costs. Competition in the contract market could lead the generators to sell contracts for much of their output. Since privatisation, the generators have indeed covered most of their sales in the contract market.

Futures market efficiency, the unbiasedness hypothesis and variance-bounds tests: the case of the ftse-100 futures contract*

Abstract: The efficiency of futures markets is critical to their price discovery role. This paper investigates the joint hypothesis of market efficiency and unbiasedness of futures prices for the FTSE-100 stock index futures contract. Unlike previous studies, it tests for both long-run and short-run efficiency using cointegration and error correction models. Variance-bounds tests are developed and utilized for examining the question of efficiency. Results show that the market is efficient and provides an unbiased estimate of future spot prices for one and two months away from expiration. However, for three and more months away from expiration this is not the case, which has implications for the users of this market.

The dual listing of stock index futures: arbitrage, spread arbitrage and currency risk

Abstract: This paper shows that riskless spot-futures arbitrage is impossible if the futures contract multiplier is in a foreign currency from that of the underlying shares. However, a no-arbitrage condition involving only futures contracts (spread arbitrage) exists for such cases when there is also a future with a contract multiplier in the same currency as the underlying shares. Where the contract multiplier of the second future is in a foreign currency, virtually riskless arbitrage is possible. Mispricings from this no-arbitrage condition were investigated for Nikkei Stock Average futures traded in Osaka, Singapore, and Chicago

Contract expiration and sales price

Abstract: This article represents the first empirical attempt to detect the relationship between sales price and listing (or contract) period. Specifically, we examine the relationship between sales price and contract expiration days. Our hypothesized positive relationship between sales price and contract expiration days is borne out by the results of this study. These results show that the home seller is able to exact a price premium of 0.04% per contract day that he/she is able to preserve. Alternatively stated, he/she will concede a price discount of 0.04% per day, on average, as the sales contract approaches its expiration. Simple analyses of time on the market (TOM) without controlling for listing period may yield misleading signals.

Optional real-time pricing of electricity for industrial firms

Abstract: . This paper proposes a pricing mechanism, optional real-time pricing (RTP), with day-ahead hourly prices, that exploits the potential offered by a competitive wholesale power market. When an electric utility offers the option to its industrial customers, the retail prices are based on an existing Hopkinson tariff and expectations as to the wholesale market's next-day hourly spot prices. The proposed RTP mechanism is Pareto-superior to the tariff in that it assures both the utility and the customer of profits that will be at least as great as under the tariff.

Spot price volatility, information and futures trading: evidence from a thinly traded market

Abstract: The impact of futures trading on spot volatility is examined for a thinly traded contract, the FTSE Eurotrack. Futures trading increases the rate at which information is impounded into prices and reduces persistence. These benefits cease after the suspension of trading. The results suggest that even in a thinly traded market the existence of futures has a beneficial impact on price discovery in the underlying spot market. The paper highlights the need to determine not only whether spot price volatility changes after the introduction of futures trading, but also, if it does, why it does, before drawing policy conclusions about the regulation of futures markets. Failure to address the latter issue may lead to inappropriate policy conclusions.

Imperfect Hedging and Export Production

Abstract: Firms engaged in international operations are highly interested in developing ways to protect themselves from exchange rate risk. The incentive for risk management comes from the enormous volatility of the floating foreign exchange rates.' Our study shows that an exporting firm can benefit from hedging exchange rate risks even when no perfect hedge is possible. Since in reality, not every currency is traded in a futures market [7, Chap. 15], the exporting firm uses futures contracts with other underlying assets whose spot prices are highly correlated with the foreign exchange spot rate. In the real world hedging must often be accomplished by using futures contracts on different deliverable instruments. Such hedging may result in imperfect hedging as shown by Anderson and Danthine [1], Eaker and Grant [11], Dellas and Zilberfarb [9], Broll, Wahl and Zilcha [6]. It has been shown in recent publications [12; 8; 15; 13; 23; 16; 2; 14; 5; 18; 22] that an international firm facing exchange rate risk can eliminate this risk altogether if it can use a currency forward market, another financial asset or a portfolio of assets which is perfectly correlated to the exchange rate. In the absence of such markets, the firm can reduce its income risk by engaging in a hedging activity of assets correlated to the foreign exchange. Recent studies of firm behavior under exchange rate uncertainty examine the influence of futures markets on the export and hedging decision. These papers derive two major theorems: One is the "separation theorem" which states that, when futures markets exist, the firm's export production decision is determined solely by technology and input-output prices, including the futures prices. This result holds if the gain from the futures contract is perfectly correlated with export revenue. The other theorem is the "full hedging theorem" which asserts that with unbiased futures markets, the firm completely avoids exchange rate risk by entering into optimum futures contracts.

Forecasting interest rates from financial futures markets

Abstract: The prices of financial futures contracts traded at LIFFE can be interpreted as forecasts of the three-month interest rate which will apply at the delivery date. During the period under review the contracts were traded daily for a varying number of years prior to the delivery date so that a number of contracts are priced at any one time. The paper outlines the institutional framework of the contracts and examines how prices change for 12 three-month interest contracts for each of (i) short sterling and (ii) Eurodollar. The series are tested individually for the presence of unit roots, for unbiasedness and changing volatility. Variation across series is also examined. Finally, the Eurodollar and short-sterling interest rate contracts are examined over the period 1982 to 1994 to ascertain whether the futures price is cointergrated with the realized spot price. Further tests are carried out to see if the futures price incorporates information other than that contained in the spot price.

Procedures for Computing Equilibria of the Oligopoly Expansion Game under Predetermined Multi-Period Pricings. Part 1: Short-Run Optimal Spot Pricing

Abstract: Long-run oligopolistic expansion behavior in an electricity supply market is modeled in the paper. The market is assumed to charge electricity prices equal to short-run marginal costs plus optimal rationing prices (optimal spot prices). Electricity generation firms can affect prices (and then affect their profit) only by their capacity. A two-stage game is used to model this market: first, firms independently and simultaneously invest their capacity; second, after these capacities are set up, firms sell electricity produced by them at optimal spot prices. An iterative procedure is formulated for computing equilibria of the game. In each cycle of the procedure, a set of three models, a Nasb-Cournot model, a short-run welfare optimization model and a short-run cost minimization model with fixed demand, are successively solved until a fixed point is obtained. It is shown that when the peak supply at all nodes are higher than the off-peak supply or the peak prices are upper bounded not higher than the Cournot prices, the fixed point of the procedure constitutes an equilibrium of the two-stage game. A minor modification of the procedure is used to model a long- run oligopoly where threat of entry exists. A market organized by three European countries is simulated by the procedure.

The Intertemporal Relationship Between the Currency Spot Market and the Currency Option Market

Abstract: This study examines the lead/lag relationship between currency option and currency spot markets for the Deutsche mark and the Japanese yen. Using intraday currency option transactions data for the year 1989 and applying a European type currency option pricing model, pair data series of the implied and the observed exchange rates are compiled. Causality tests are then employed to test the causal relation between the observed and the implied exchange rate changes. The results indicate that the currency spot market leads the currency option market by about ninety minutes.

Portfolio hedging and basis risks

Abstract: Minimum variance hedged portfolios using futures are formed by taking the linear projection of spot price changes onto futures price movements as the hedge ratio. This unwittingly assumes that the underlying spot-futures price movements follow a cointegrated process, given that the spot and the futures prices are integrated processes. If the spot-futures prices are not cointegrated, the hedged portfolio suffers from the risk of potentially large changes in its value. Empirical findings using the Nikkei stock index and the Nikkei 225 futures show this deviation in intraday trading prices. The basis movements which have often been used by intraday traders to predict future price changes, are tested to be mostly unit root processes. This is shown to be due largely to non-cointegration of the spot-futures prices, and suggests why it is profitable to trade futures using basis knowledge only if trading is done on a continual basis.

A Remark on American Securities

Abstract: In this paper, we discuss about American securities. To simplify the notions, we only discuss the case that the free risk spot rate is zero and the maturity (or the horizon) is 1 (So the price of free risk bond is constant). Also we assume that there is no dividend or no transaction cost and that there is no restriction on short sale.

Government Rail Car Regulation and the Price of Canola

Abstract: In this paper I analyze Canadian government regulation of rail transportation as it affects the domestic price of canola in both the street and futures market. The regulation gives rise to an idiosyncrasy: Vancouver canola futures and Vancouver spot prices do not converge, with futures trading at a significant premium to spot prices during the delivery month. As a result, Vancouver futures prices do not reflect international market conditions. I offer an explanation of the futures premium. In addition, I find that there is evidence to support a contention that a change in rail car policy in 1989 improved canola throughput efficiency in Vancouver and may have led to higher street prices.

A two-stage mechanism to improve electricity rationing

Abstract: Electricity cannot be stored economically and must be generated on demand. Because electricity demand is subject to cyclical and random fluctuations, an equilibrium price would change constantly and spot pricing would generate substantial information and transactions costs. In the absence of spot prices, the utility must install enough capacity to meet peak demand with a given probability, and design a rationing plan for when the reserve margin proves inadequate. To avoid building new generation facilities, electric utilities have devised innovative rationing plans. These plans, referred to as load management programs, allow the utility to curtail loads of a pre-determined group of consumers. Interruptible/Curtailable (I/C) programs are among the most popular.' Much of the analysis of these mechanisms has focused on the efficiency losses due to the absence of complete contingent contracts. Because transaction costs prevent the implementation of contracts which fully represent the states of nature, there is inefficiency in allocation at the time of interruption. There exists a second type of inefficiency which has largely been ignored. A central hypothesis underlying all of these models is that the relative order, or ranking, of consumers' willingness to pay remains unchanged throughout the contract period. This is a fairly restrictive assumption. In much the same way that prohibitive transaction costs preclude the use of complete contingent contracts, these costs also make it necessary that I/C contracts have relatively long durations (say 3-5 years). Within a long contract period, it seems unrealistic to assume invariance in the ordering of consumers' willingness to pay. Thus it becomes impossible to achieve an efficient allocation, at the time of interruption, without some revelation by consumers of their willingness to pay at the time of interruption.

A simultaneous, rational expectations model of the Australian dollar/US dollar market

Abstract: A simultaneous, rational expectations model of the Australian dollar/US dollar foreign exchange market is presented, using information from both spot and futures markets. Tests for unit roots are conducted, and in no case can the hypothesis of a single unit root in either the spot rate or the futures rate be rejected. Cointegration tests also are reported, and following minor respecification of the model, the hypothesis of no cointegration is rejected for all equations. All parameter estimates are of the expected sign, and virtually all parameter estimates are significant. Intra-sample, the model simulates futures and spot exchange rates with per cent RMSEs of 2.7% and 2.6% respectively, while post-sample per cent RMSEs for futures and spot rates are 1.2% and 0.65%. The model significantly outperforms a random walk forecast of the spot rate post-sample, and also significantly surpasses the forecast of a lagged futures rate, this last result being evidence against the efficient markets hypothesis.

The Brent contract for differences (CFD) : a study of an oil trading instrument, its market and its influence on the behaviour of oil prices

Abstract: The decision to undertake a study of the Brent CFD (Contract for Differences) market was made for two reasons. The first is that the Institute has done major research work on the various constituents of the Brent market complex in an almost continuous manner since 1984. This led to the publication of two books, The Market for North Sea Crude Oil (1986)l and Oil Markets and Prices (1993),’ and a number of related working papers and monographs on other oil markets and trading instruments. When researching for the most recent of these two books, very little was known about the CFD market. As a result there were only some cursory references to CFDs in Oil Markets and Prices.