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Arbitrage, Risk Premium, and Cointegration Tests of the Efficiency of Futures Markets

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  • Ying‐Foon Chow

Abstract

This article provides a new perspective on the efficiency of futures markets in a cointegration framework. Under the conventional risk premium hypothesis, if futures and spot prices are non‐stationary, they must be cointegrated if futures markets are efficient. Alternatively, the cost‐of‐carry model implies that there should be a cointegration relationship among spot prices, futures prices and interest rates assuming all the series contain a unit root. Market efficiency further implies specific parameter restrictions under these two models. Using data on the futures markets for gold, silver, palladium and platinum, this article first establishes that interest rates, spot and futures prices are unit root non‐stationary. The evidence on cointegration is somewhat mixed: the gold futures market is consistent with the cost‐of‐carry model, and the silver futures market satisfies the risk premium hypothesis, but the evidence for the other two markets is inconclusive.

Suggested Citation

  • Ying‐Foon Chow, 2001. "Arbitrage, Risk Premium, and Cointegration Tests of the Efficiency of Futures Markets," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 28(5‐6), pages 693-713, June.
    • Handle: RePEc:bla:jbfnac:v:28:y:2001:i:5-6:p:693-713
    DOI: 10.1111/1468-5957.00390
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    1. Ying-Foon Chow, 2001. "Arbitrage, Risk Premium, and Cointegration Tests of the Efficiency of Futures Markets," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 28(5-6), pages 693-713.
    2. Jerry Coakley & Jian Dollery & Neil Kellard, 2011. "Long memory and structural breaks in commodity futures markets," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 31(11), pages 1076-1113, November.
    3. repec:dau:papers:123456789/1244 is not listed on IDEAS
    4. Narayan, Paresh Kumar & Liu, Ruipeng, 2011. "Are shocks to commodity prices persistent?," Applied Energy, Elsevier, vol. 88(1), pages 409-416, January.
    5. Xu, Xiaoqing Eleanor & Fung, Hung-Gay, 2005. "Cross-market linkages between U.S. and Japanese precious metals futures trading," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 15(2), pages 107-124, April.
    6. Aruga, Kentaka & Managi, Shunsuke, 2011. "Testing the international linkage in the platinum-group metal futures markets," Resources Policy, Elsevier, vol. 36(4), pages 339-345.
    7. Judge, Amrit & Reancharoen, Tipprapa, 2014. "An empirical examination of the lead–lag relationship between spot and futures markets: Evidence from Thailand," Pacific-Basin Finance Journal, Elsevier, vol. 29(C), pages 335-358.

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