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Title: The differences between forward and future prices : analysis and implications
Author: Hsu, Ching Jun
Awarding Body: University of Manchester
Current Institution: University of Manchester
Date of Award: 1996
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This thesis explores the difference between Euromark futures and forward prices by analyzing the basis. We first identify and observe the existence of basis and examine the maturity effect on futures prices volatility with the Samuelson (1965) Hypothesis. We then attempt to explain the basis pattern and the pricing of Euromark futures by testing the Cox, Ingersoll, and Ross (1981) propositions. We also adopt the Johnson (1960) and Ederington (1979) Regression model and Mean-Extended Gini model developed by Shalit (1995) to evaluate the hedging performance of Euromark futures. Because some data are not directly observable, we use the linear interpolation to derive our implied forward rates and the B-Spline approximation adopted by Steeley (1991) to estimate the risk-free rate. In addition, we perform some econometric tests, including normality, stationarity, cointegration and causality tests, in order to interpret the significance of our evidence. Our test results show that the basis pattern of Euromark futures will generally switch from backwardation several months before the last trading day (LTD) to contango as it approaches to the LTD and there is a tendency for the basis to remain negative until the LTD. In addition, our test results generally do not support the Samuelson (1965) hypothesis that the variance of futures price changes increases as the delivery date approaches. Among all the assumptions concerning the differences between forward and futures prices, the marking-to-market effect has become the most commonly recognized critical factor. The marking-to-market effect, also called eIR effect, explains basis pattern by different payment streams combined with stochastic interest rates. We test eIR's'sign proposition (the relationship between futures/forward prices and bond prices) and magnitude proposition (the relationship among spot prices, futures prices, forward prices and bond prices) as well as the relationship between futures prices and interest rates. Although our test results generally do not strongly support all of eIR's propositions, we attribute these failures to measurement errors and incomplete models. However, overall the basis does not reduce hedging risk. Hedging is a conventional purpose of futures contracts. Since the portfolio explanation of hedging theory has become increasingly popular, we compare the hedging performance between the minimum-variance Regression model and the utility-maximizing Mean- Extended Gini hedging method. The results show that using both models, the basis effect is similar. Using the distant contract, basis has the most significant minimum- variance effect, and hedging performance is improved as variance decreases. We conclude that the minimum-variance hedging is possibly the optimal hedging only in an unbiased futures market, where there is no basis effect.
Supervisor: Not available Sponsor: Not available
Qualification Name: Thesis (Ph.D.) Qualification Level: Doctoral
EThOS ID:  DOI: Not available