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An Anatomy of Futures Returns: Risk Premiums and Trading Strategies

Author

Listed:
  • Frans A. de Roon
  • Rob W. J. van den Goorbergh
  • Theo E. Nijman

Abstract

This paper analyzes trading strategies which capture the various risk premiums that have been distinguished in futures markets. On the basis of a simple decomposition of futures returns, we show that the return on a short-term futures contract measures the spot-futures premium, while spreading strategies isolate the term premiums. Using a broad cross-section of futures markets and delivery horizons, we examine the components of futures risk premiums by means of passive trading strategies and active trading strategies which intend to exploit the predictable variation in futures returns. We find that passive strategies which capture the spot-futures premium do not yield abnormal returns, in contrast to passive spreading strategies which isolate the term premiums. The term structure of futures yields has strong explanatory power for both spot and term premiums, which can be exploited using active trading strategies that go long in low-yield markets and short in high-yield markets. The profitability of these yield-based trading strategies is not due to systematic risk. Furthermore, we find that spreading returns are predictable by net hedge demand observed in the past, which can be exploited by active trading. Finally, there is momentum in futures markets, but momentum strategies do not outperform benchmark portfolios.

Suggested Citation

  • Frans A. de Roon & Rob W. J. van den Goorbergh & Theo E. Nijman, 2004. "An Anatomy of Futures Returns: Risk Premiums and Trading Strategies," WO Research Memoranda (discontinued) 757, Netherlands Central Bank, Research Department.
  • Handle: RePEc:dnb:wormem:757
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    File URL: https://www.dnb.nl/binaries/research%20memorandum%20wo%20no%20757_tcm46-146037.pdf
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    References listed on IDEAS

    as
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    5. Bessembinder, Hendrik, et al, 1995. " Mean Reversion in Equilibrium Asset Prices: Evidence from the Futures Term Structure," Journal of Finance, American Finance Association, vol. 50(1), pages 361-375, March.
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    More about this item

    Keywords

    Predictability; futures term structure; hedging pressure;

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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