Abstract
The theories for the existence of futures markets, that of supply of storage, and normal backwardation, allow for the possibility of the relationship between futures and spot being at full carry under certain conditions (very high level of inventories for the former, and net short hedging equaling net long hedging in the latter). Using arbitrage arguments, it is shown that a market at full carry provides a free option to the cash and carry trader. The assumption of arbitrage free markets rules out the possibility of the existence of a free option. Since this option will be priced in the spread between the spot and futures prices, efficient markets preclude the existence of a full carry market. Regression and cointegration tests are used to show that the futures-spot relationship includes an option component.
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