An application of arbitrage pricing theory to futures markets: Tests of normal backwardation

Ehrhardt, Michael C.; Jordan, James V.; Walkling, Ralph A.

doi:10.1002/fut.3990070104

Cited by 23 publications

(13 citation statements)

References 26 publications

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“…At least for these futures, the theory of normal backwardation first proposed by Keynes in 1930 seems to apply. In particular, the results for the corn, soybeans, and wheat contracts that inspired a wide literature (Baxter et al, 1985;Carter et al, 1983;Dusak, 1973;Ehrhardt et al, 1987;Park et al, 1988;Young, 1991) strongly support the predictions of the normal backwardation theory. The premium for holding currency futures is negative, suggesting that the contango theory is valid in the foreign exchange futures market.…”

Section: Discussionsupporting

confidence: 69%

“…The rationale for the use of multifactor models in this context is that a more dissaggregated risk structure may be useful for explaining the cross section of expected futures returns. Ehrhardt, Jordan, and Walkling (1987) used factor analysis in commodity futures markets and did not claim support to the Keynesian hypothesis. Park, Wei, and Frecka (1988) used principal components analysis and also failed to support the predictions of the normal backwardation theory in commodity futures markets.…”

Section: The Cross Section Of Expected Futures Returns: a Reviewmentioning

confidence: 90%

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Normal backwardation is normal

Miffre

2000

J. Fut. Mark.

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Section: Discussionsupporting

confidence: 69%

Section: The Cross Section Of Expected Futures Returns: a Reviewmentioning

confidence: 90%

Normal backwardation is normal

Miffre

2000

J. Fut. Mark.

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“…Second, the parameter cgs measures the response of gold futures volatility to last period's squared pricing shocks of silver futures (es,t-l); the parameter csg measures the response of silver futures volatility to last period's squared pricing shocks in the gold futures market (E:, t -1 ) . Nonlinear optimization techniques are used to calculate maximum likelihood estimates of the parameters by iteratively minimizing the negative conditional log likelihood function of the following form:2' Dusak (1973) and Erhardt, Jordan, and Walkling (1987). See also Bcssemhinder (1993) and Krehhiel and Adkins (1993).…”

Section: The Bivariate Garch Model Specificationmentioning

confidence: 99%

Conditional dynamics and optimal spreading in the precious metals futures markets

Wahab

1995

Journal of Futures Markets

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“…Tests under the CAPM or the Arbitrage Pricing Theory (APT), on the other hand, find no significant risk premium in futures prices (see Dusak (1973); Baxter, Conine, and Tamarkin (1984); Ehrhardt, Jordan, and Walkling (1987); and So (1987)). Only departures from the traditional framework of the CAPM show a risk premium in futures prices (see Raynauld and Tessier (1984) and Chang (1985)).…”

Section: Literature Reviewmentioning

confidence: 99%

Systematic skewness in futures contracts

Junkus

1991

Journal of Futures Markets

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nder the Capital Asset Pricing Model (CAPM), the excess rate of return on a U risky asset depends on its contribution to the variance of the market portfolio, that is, its systematic risk. The CAPM has been applied to futures contracts in an effort to discover, and measure the size of, a risk premium for these assets. However, the existence of a risk premium in futures contracts and its size remains a subject of controversy.The mean-variance asset pricing model has been extended to three moments in common stocks to include a positive investor preference for systematic skewness of asset return. This article tests a three-moment version of the CAPM for futures contracts.Several issues relating to a risk premia in futures are addressed. First, applying a three-moment pricing model to futures contracts can shed light on the nature of the risk premium in futures. Since commodity futures appear to have little systematic risk, it may be that the risk of these contracts takes a form other than the usual covariance with the market. A three-moment asset pricing model that incorporates more information on futures returns distributions may be more appropriate for futures contracts than the traditional CAPM.Second, systematic co-skewness is consistent with a two-factor Arbitrage Pricing Model of asset returns: if investors exhibit a positive preference for skewness, a second, quadratic market factor may have significance in explaining returns on futures contracts. Therefore, this article also tests a two-factor, quadratic asset pricing model for futures contracts.Third, the significance of co-skewness is tested using three different proxies for the market portfolio: the S&P500, the traditional measure of the market portfolio; a combined commodity cash price/S&PSOO portfolio, reflecting the relative weighting of commodities in the U.S. wealth portfolio; and a 100% commodity portfolio representing a well-diversified portfolio of agricultural wealth. It may be that coskewness, like systematic risk in futures, depends on the composition of the market portfolio used to test for its significance. Use of an agricultural portfolio makes the strongest possible case for the explanatory power of systematic risk or systematic co-skewness in futures returns because the correlation between futures returns and an agricultural wealth portfolio (thereby the measure of risk for the futures) should be high. Finally, the tests for risk premia in futures are conducted here on a much larger number of contracts than have been used in previous studies.The results of this article show that futures are not risky assets, despite their apparent volatility, within either a 2-or 3-moment asset pricing model. Further, fuJoan C. Junkus is an Associate Professor of Finance at DePaul University.

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An application of arbitrage pricing theory to futures markets: Tests of normal backwardation

Cited by 23 publications

References 26 publications

Normal backwardation is normal

Normal backwardation is normal

Conditional dynamics and optimal spreading in the precious metals futures markets

Systematic skewness in futures contracts

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