Abstract
This paper sheds light on the relationship between the Nasdaq Composite Index and a newly proposed Energy Futures Conditions Index (EFCI). While various financial conditions indices provide information about the financial stability of a country, the existence of an energy condition index, using futures markets, is scarce. Using weekly data over the period 1992–2017, this paper introduces an energy futures index using principal component analysis and test its predictability over the Nasdaq Composite Index. The EFCI captures 95% of the variability inherent in crude oil, heating oil and natural gas futures’ total reportable positions. Stability in forecast errors over different lags suggests a one week lag is sufficient to forecast weekly Nasdaq Composite Index. 95% prediction levels support that the estimated model captures actual equity market index values, except for the 2000 technology bubble. Distributions of level data were non-normal, not serially correlated and homoscedastic under the whole sample period, with diagnostics on pre and post technology bubble crisis showing mixed results. While differencing ensured homoscedastic errors in the forecasting model, Granger causality supported non-causality from both energy futures and equity markets, suggesting no evidence of cross market information flows.
Highlights
The role of speculators in globalized markets can arguably be traced back to early studies like Kaldor (1939), Working (1953), Nurske (1944) and Friedman (1953)
Stability in forecast errors over different lags suggests a one week lag is sufficient to forecast weekly Nasdaq Composite Index. 95% prediction levels support that the estimated model captures actual equity market index values, except for the 2000 technology bubble
Despite studies that focus on the relationship between energy futures conditions and equity markets movements is scarce, some studies looked at the relationships between net positions of key market players in specific futures markets and risk and return
Summary
The role of speculators in globalized markets can arguably be traced back to early studies like Kaldor (1939), Working (1953), Nurske (1944) and Friedman (1953). Kliesen, Owyang, and Vermann (2012) summarized the major variables in US FCIs. Despite studies that focus on the relationship between energy futures conditions and equity markets movements is scarce, some studies looked at the relationships between net positions of key market players in specific futures markets and risk and return. Findings from this paper are critical, since it helps to shed light whether the biggest players’ transactions, through reportable positions in the energy futures markets, can potentially affect stock market index movements. This allows regulatory bodies such as the Commodity Futures Trading Commission (CFTC) and the Securities Exchange Commission (SEC) to be more informative in their mandate of promoting greater price stability in financial markets. The analysis section follows with descriptive statistics, forecasting results, including diagnostics, before ending with a conclusion
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