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Financial frictions and the futures pricing puzzle

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  • ap Gwilym, Rhys
  • Ebrahim, M. Shahid
  • El Alaoui, Abdelkader O.
  • Rahman, Hamid
  • Taamouti, Abderrahim

Abstract

In perfect capital markets, the futures price of an asset should be an unbiased forecast of its realized spot price when the contract matures. In reality, futures prices are often higher for some assets and lower for others. However, there is no stability in the relationship between futures prices and the realized spot prices. This instability has been a puzzle in the existing financial literature. The key to this puzzle may lie in the nature of the model and the lack of market imperfections. In this study, we take a theoretical approach in a dynamic multi-period environment. We incorporate competition between disparate economic agents and impose financial frictions (i.e., imperfections) that are in the form of hedging and borrowing limits on them. Our model gives rise to multiple equilibria, each with unique market clearing prices, with the market switching between these equilibria. Our analysis incorporates a comprehensive consideration of the risks faced by the futures markets participants (i.e., speculators and hedgers) and leads to a better understanding of the puzzle.

Suggested Citation

  • ap Gwilym, Rhys & Ebrahim, M. Shahid & El Alaoui, Abdelkader O. & Rahman, Hamid & Taamouti, Abderrahim, 2020. "Financial frictions and the futures pricing puzzle," Economic Modelling, Elsevier, vol. 87(C), pages 358-371.
  • Handle: RePEc:eee:ecmode:v:87:y:2020:i:c:p:358-371
    DOI: 10.1016/j.econmod.2019.08.009
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    More about this item

    Keywords

    Futures pricing; Contango; Financial frictions; Normal backwardation;
    All these keywords.

    JEL classification:

    • D58 - Microeconomics - - General Equilibrium and Disequilibrium - - - Computable and Other Applied General Equilibrium Models
    • D74 - Microeconomics - - Analysis of Collective Decision-Making - - - Conflict; Conflict Resolution; Alliances; Revolutions
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • N20 - Economic History - - Financial Markets and Institutions - - - General, International, or Comparative

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