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The Futures Pricing Puzzle

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  • Shafiqur Rahman
  • M. Shahid Ebrahim

Abstract

This paper models commodity futures in a rational expectations equilibrium specifically (i) incorporating the conflict of interests between Hedgers (Producers-Consumers) and Speculators and (ii) superimposing constraints to immunize the real sector of the economy from shocks of excessive futures contracting. We extend the framework of Newbery and Stiglitz (1981), Anderson and Danthine (1983) and Britto (1984) to attribute the conflicting and puzzling results in the empirical literature to the presence of multiple equilibria ranked in a pecking order of decreasing pareto-efficiency. Thus, we caution empirical researchers on making inferences on data embedded with moving equilibria, as it can render their analysis of asset pricing mechanism incomprehensible. Finally, we rationalize the imposition of position limits by policy makers to help steer the equilibria to pareto-inferior ones, which make the real sector of the economy more resilient to shocks from the financial sector

Suggested Citation

  • Shafiqur Rahman & M. Shahid Ebrahim, 2005. "The Futures Pricing Puzzle," Computing in Economics and Finance 2005 35, Society for Computational Economics.
  • Handle: RePEc:sce:scecf5:35
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    File URL: http://repec.org/sce2005/up.21268.1104875537.pdf
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    References listed on IDEAS

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    1. Breeden, Douglas T, 1980. " Consumption Risk in Futures Markets," Journal of Finance, American Finance Association, vol. 35(2), pages 503-520, May.
    2. A. G. Malliaris & Jerome L. Stein, 2005. "Methodological issues in asset pricing: Random walk or chaotic dynamics," World Scientific Book Chapters,in: Economic Uncertainty, Instabilities And Asset Bubbles Selected Essays, chapter 8, pages 85-115 World Scientific Publishing Co. Pte. Ltd..
    3. Angus Deaton & Guy Laroque, 1992. "On the Behaviour of Commodity Prices," Review of Economic Studies, Oxford University Press, vol. 59(1), pages 1-23.
    4. Hartzmark, Michael L, 1987. "Returns to Individual Traders of Futures: Aggregate Results," Journal of Political Economy, University of Chicago Press, vol. 95(6), pages 1292-1306, December.
    5. Sheffrin,Steven M., 1996. "Rational Expectations," Cambridge Books, Cambridge University Press, number 9780521479394, April.
    6. Maddock, Rodney & Carter, Michael, 1982. "A Child's Guide to Rational Expectations," Journal of Economic Literature, American Economic Association, vol. 20(1), pages 39-51, March.
    7. Rolfo, Jacques, 1980. "Optimal Hedging under Price and Quantity Uncertainty: The Case of a Cocoa Producer," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 100-116, February.
    8. Ronald Britto, 1984. "The Simultaneous Determination of Spot and Futures Prices in a Simple Model with Production Risk," The Quarterly Journal of Economics, Oxford University Press, vol. 99(2), pages 351-365.
    9. Carter, Colin A & Rausser, Gordon C & Schmitz, Andrew, 1983. "Efficient Asset Portfolios and the Theory of Normal Backwardation," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 319-331, April.
    10. Chambers, Marcus J & Bailey, Roy E, 1996. "A Theory of Commodity Price Fluctuations," Journal of Political Economy, University of Chicago Press, vol. 104(5), pages 924-957, October.
    11. Young, Leslie & Boyle, Glenn W., 1989. "Forward and futures prices in a general equilibrium monetary model," Journal of Financial Economics, Elsevier, vol. 24(2), pages 319-341.
    12. Turnovsky, Stephen J, 1983. "The Determination of Spot and Futures Prices with Storable Commodities," Econometrica, Econometric Society, vol. 51(5), pages 1363-1387, September.
    13. Newbery, David M, 1989. "The Theory of Food Price Stabilisation," Economic Journal, Royal Economic Society, vol. 99(398), pages 1065-1082, December.
    14. Marcus, Alan J, 1984. "Efficient Asset Portfolios and the Theory of Normal Backwardation: A Comment," Journal of Political Economy, University of Chicago Press, vol. 92(1), pages 162-164, February.
    15. Lester G. Telser, 1958. "Futures Trading and the Storage of Cotton and Wheat," Journal of Political Economy, University of Chicago Press, vol. 66, pages 233-233.
    16. Jagannathan, Ravi, 1985. " An Investigation of Commodity Futures Prices Using the Consumption-based Intertemporal Capital Asset Pricing Model," Journal of Finance, American Finance Association, vol. 40(1), pages 175-191, March.
    17. David Hirshleifer, 1988. "Residual Risk, Trading Costs, and Commodity Futures Risk Premia," Review of Financial Studies, Society for Financial Studies, vol. 1(2), pages 173-193.
    18. Fama, Eugene F & French, Kenneth R, 1987. "Commodity Futures Prices: Some Evidence on Forecast Power, Premiums,and the Theory of Storage," The Journal of Business, University of Chicago Press, vol. 60(1), pages 55-73, January.
    19. Chang, Eric C, 1985. " Returns to Speculators and the Theory of Normal Backwardation," Journal of Finance, American Finance Association, vol. 40(1), pages 193-208, March.
    20. Anderson, Ronald W & Danthine, Jean-Pierre, 1983. "Hedger Diversity in Futures Markets," Economic Journal, Royal Economic Society, vol. 93(37), pages 370-389, June.
    21. Dusak, Katherine, 1973. "Futures Trading and Investor Returns: An Investigation of Commodity Market Risk Premiums," Journal of Political Economy, University of Chicago Press, vol. 81(6), pages 1387-1406, Nov.-Dec..
    22. Bessembinder, Hendrik, 1992. "Systematic Risk, Hedging Pressure, and Risk Premiums in Futures Markets," Review of Financial Studies, Society for Financial Studies, vol. 5(4), pages 637-667.
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    More about this item

    Keywords

    Contango; Expectations; Normal Backwardations;

    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
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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