Future Spot Research Articles

From volatility smiles to the volatility of volatility

The paper reviews models of the option surface and reduced-form models for stochastic volatility in continuous time, under the risk-neutral measure. It defines “forward volatilities,” analogous to forward interest rates in the theory of the term structure, and provides a proof that the forward volatility is a conditional expected value, under the risk-neutral measure, of the future spot volatility. The theory developed here is the analog of Heath–Jarrow–Morton bond-pricing theory. The link is established between forward volatilities and so-called “model-free” volatility measures such as the VIX.

Volatility information trading in the index options market: An intraday analysis

By analyzing intraday volatility information trading according to the demand for options, we determine the types of investors that are informed about future spot market volatility and conduct volatility information trading in a highly liquid options market. Although the overall aggregate options demand does not predict intraday market volatility, the vega-weighted net demand of foreign investment firms conveys significant information about future volatility dynamics. By tracking the positions of all options market participants according to option moneyness, we find that foreign investment firms conduct volatility trading using highly levered options and that their intraday volatility information superiority is more prominent when they close their existing positions.

Modeling the Dynamic Process of the Forward Curve

In this paper, we provide adjustments for liquidity and credit risk to the forward Libor rate in order to improve accuracy of the forward rate in forecasting the 3-month Libor rate. In particular, we introduce the adjusted forward curve (AFC) that models the update in the forward curve from one period to the next. A direct modeling of the dynamic process of the forward curve facilitates the specification of adjustment factors to the forward curve, and it underscores the role of mean reversion (stationarity) in the nexus between the forward rate and the future spot rate, The AFC factors that underpin the forward curve bias are statistically relevant with p-values that are less than .00001. The upward bias in the forward curve (i.e., when the forward curve exceeds the expected future spot rate) positively correlates with the steepness of the yield curve in the AFC model. A downward bias positively correlates with the credit spread and industrial capacity utilization. Furthermore, the effect of the instantaneous forward curve on the future spot rate tempers off with time. The predictive power of the AFC model, however, hinges on the forecastability of the underlying factors. The testing indicates that all the AFC model factors have a mean reversion component. Overall, our model effectively anticipates movements in the forward curve that tend to yield a better forecast of the future spot rate.

An Adjusted Forward Curve for Spot Rate Forecasting

In this paper, we provide adjustments for liquidity and credit risk to the forward Libor rate in order to improve accuracy of the forward rate in forecasting the 3-month Libor rate. In particular, we introduce the adjusted forward curve (AFC) that models the update in the forward curve from one period to the next. A direct modeling of the dynamic process of the forward curve facilitates the specification of adjustment factors to the forward curve, and it underscores the role of mean reversion (stationarity) in the nexus between the forward rate and the future spot rate. The AFC factors that underpin the forward curve bias are statistically relevant with p-values that are less than .00001. The upward bias in the forward curve (i.e., when the forward curve exceeds the expected future spot rate) positively correlates with the steepness of the yield curve in the AFC model. A downward bias positively correlates with the credit spread and industrial capacity utilization. Furthermore, the effect of the instantaneous forward curve on the future spot rate tempers off with time. The predictive power of the AFC model, however, hinges on the forecastability of the underlying factors. The testing indicates that all the AFC model factors have a mean reversion component. Overall, our model effectively anticipates movements in the forward curve that tend to yield a better forecast of the future spot rate.

Palm oil spot-futures relation: Evidence from unrefined and refined products

This study examines the palm oil spot-futures relation in terms of mean and volatility spillovers from 2010 to 2018. Based on the cross-correlation function of standardised residuals and its squared residuals, our results show: first, crude palm oil (CPO) futures returns Granger cause refined palm oil, palm stearin and palm olein spot returns. Second, refined palm kernel oil spot returns Granger cause crude palm kernel oil futures returns in mean and variance. Third, CPO spot and refined palm olein futures returns are independent; and fourth, there is volatility spillover from CPO futures market to refined palm oil spot market within longer time. These findings suggest that refiners can use CPO futures returns instead of crude palm kernel oil futures returns for predicting the future spot return of refined palm oil products. To lock in purchasing price of unrefined palm oil products, the producers can rely on the spot volatility to decide the optimal number of crude palm kernel oil futures contracts.

Forward Curve Bias and Optimization Errors

We derive optimal hedging ratios for interest rate risk under different assumptions that underpin the relationship between the forward rate and the expected future spot rate. In some instances, full hedging is optimal, and the conditions for the optimality of a partial hedge are identified. Less hedging (more floating debt in our model) is more optimal under the liquidity preference model than under the unbiased expectations hypothesis. This indicates that in times of higher preference for liquidity less hedging is optimal. Higher preference for liquidity correlates with larger term spreads (a steeper yield curve) and periods of monetary easing. Comparison of the analytical results with historical data indicates that partial hedging for interest rate risk is generally preferable over full hedging strategies with some exceptions. Lastly, the paper shows the role of market timing on hedging decisions.

Prediction and explanation of the formation of the Spanish day-ahead electricity price through machine learning regression

Until recently, detailed information on the power system state to estimate future spot prices by regression analysis was generally restricted to qualified parties. However, to ensure transparency in operation, the Spanish Transmission System Operator has launched an informative web in which a sizable amount of real-time energy-related data can be consulted through a graphical interface. Undoubtedly, this provides the opportunity for non-qualified parties to develop applications and algorithms in which price forecast and maybe knowledge about how price is determined are required.This paper approaches the use of data extracted from that interface with two aims: the prediction of the day-ahead price in a simple way, and the exploration of the influence that the underlying energy drivers have on it. For the prediction we specified a quantile regression model based on Gradient Boosted Regression Trees. It improves the accuracy over multiple linear regression models at the cost of more complexity, and still it has simpler specification and tuning compared to other machine learning approaches. The calculated metrics show that our model produces remarkably low prediction errors when using the median as point prediction method (RMSE = 2.78 €/MWh, MAE = 1.94 €/MWh, and MAPE = 0.059). Interestingly, the quantile regression model also allows to inherently define prediction intervals, with a different interpretation of accuracy. Our results show that on average 90% of times the prediction error will not exceed 6.8 €/MWh.We also implemented a partial dependence analysis on that model. This implementation—as far as we know the first time employed to analyze the formation of electricity prices—has shown to be of significant usefulness in detecting highly non-linear relationships.

Lolling and the Suspension of Salvation inPiersPlowman

This article suggests that the temporal schematics of lolling and hanging in Piers Plowman reveal the inequities of fourteenth-century salvific politics and expose the precariousness of temporally-bound subjects from whom institutional powers benefit. Since the poem identifies the suspended pause of lolling as both necessary for and an obstruction to Christ’s return, Piers Plowman takes seriously the precariousness of lolling subjects and questions how those who are suspended in time and body can dowel and secure a spot in a salvific future.

Efficiency and Forecast Performance of Commodity Futures Markets

The present study empirically investigates market efficiency and the potential factors of inefficiency in the main non-energy commodity futures markets: maize, soybeans and wheat. With efficient markets, futures prices can be used as commodity price forecasts, with inefficient markets futures prices are not able to predict spot prices. Technically, exploring the drivers of inefficiency means to assess the determinants of forecast errors, i.e. the factors affecting the difference between realized spot prices and predicted future spot prices. The analysis is carried out using first a traditional test of efficiency for spot and futures prices and then implementing a more sophisticated GARCH analysis at a daily and weekly frequency. The results show that maize, soybeans and wheat markets are not informationally efficient. The realized price volatility of futures markets, the time to maturity, open interest, trading volumes and speculative measures are significant factors explaining forecast errors. In particular, short-term speculation (scalping activity) increases the noise in the information formation process. Similarly, price volatility, lack of liquidity and long contract maturity horizon raise forecast errors, while long-term speculation and speculative pressure reduce errors. The analysis suggests that knowing the causes of forecast errors, would allow to control for such factors and therefore to ameliorate the forecast accuracy of commodity prices.

Term Structure Forecasts of Volatility and Option Portfolio Returns

I examine the predictability of equity implied volatility from the term structure, and find that forward volatility levels are biased predictors of future spot implied volatility. I construct options structures which proxy for forward volatility assets, and show that a long-short portfolio of forward volatility assets produce significantly profitable returns. As the construction of the trade is borne from a violation of an expectations hypothesis, the strategy is similar to the carry trade effected in foreign exchange and other assets. Unlike the returns to carry in foreign exchange and other assets, the forward volatility assets are not exposed to liquidity or volatility risks and negatively loads on market risk.

The Impact of Restrictive Measures on the Price Discovery Function of Stock Index Futures – Evidence From CSI 500 Stock Index Futures

Restrictive measures implemented by governments have a great impact on the price discovery function of stock index futures. This study compares the price discovery function of CSI 500 stock index futures and CSI 500 stock index before and after the implementation of restrictive measures based on the reaction speed to new information, the price ratio of new information and the price contribution of both future market and spot market. It also analyzes the difference between the price discovery function of the future market and that of the spot market and thus proposes policy implications accordingly.Utilizing data of CSI 500 stock index futures in the period of the stock market crash, this study compares the price discovery function before and after the implementation of restrictive measures. By means of the VECM model and common factor analysis, it further investigates the difference in the price contribution of the two markets. Contributing to existing literature on the relationship between the future market and the spot market, this study explores the change in the price contribution of the two markets and therein studies the impact of restrictive measures on the price discovery function. Empirical evidence finds that before the implementation of restrictive measures, the price discovery function worked more efficiently, while, however, after the implementation of restrictive measures, the price discovery function did not work. Hence, stock index futures do assist in the price discovery of the spot market. In some special time periods, however, due to the impact of restrictive policies, the price contribution of the spot market exceeded that of the future market, implying that the price discovery function of the CSI 500 stock index future market is unstable.

Is Currency Futures Market at NSE India Informationally Efficient?

In a perfectly efficient and frictionless market, futures price should move concurrently with the underlying spot price without any lead or lag in price movements across markets. Futures price should be an unbiased estimator of the future spot price at the expiration date. Traders, exporters, importers and MNCs are exposed to foreign exchange risk to hedge their foreign currency exposures. They enter in to currency future contract. The hedging effectiveness depends on the efficiency of currency future market. In this paper, we analyse the efficiency of currency future market at National Stock Exchange (NSE) of India for sample period. The various parametric and non-parametric tests have been applied to test the efficiency of US $ currency futures market at NSE in India. Johansen’s Cointegration reports that US dollar futures and spot series are cointegrated and possess long run equilibrium with each other. From Granger Causality results, we find that there is one-way causality from US dollar futures to spot market. Therefore, we conclude that currency future market at NSE India is informationally efficient. Hence, US dollar futures can be used to hedge against US dollar denominated foreign exchange exposure.

Back-Testing Methods Used to Estimate Future Spot Exchange Rates Utilizing Bloomberg Data

Since students ask for real life examples and employers look for better excel skills, I added an empirical project to International Finance class. Using Bloomberg data students, in teams of four, calculate annual and average annual currency appreciations, as well as, various parity conditions between dollar and major foreign currency. In the last phase of the project students back-test methods for predicting future spot exchange rates. As an incentive to experiment with different lengths of the estimation period, the team with the smallest standard deviation between estimated and actual exchange rates earn bonus points.

Price Sensitivity of Hourly Day-ahead and Quarter-hourly Intraday Auctions in Germany

The introduction of the quarter-hourly intraday auction in 2014 for the German market confirms a tendency towards short-term energy markets. The reason for the new market was the need to trade shorter periods than just hours a day-ahead to minimize open positions in the more volatile continuous intraday trading. The increased production capacity of solar power boosted this requirement for new short-term power products. The quarter-hourly market shows a distinctive zigzag price formation. We identify two influencing factors: first, the solar residual that combines the trading of solar power ramps around midday as well as the gradients of consumption and thermal power plant ramps throughout the course of the day, and second, a characteristic two stage market design with higher liquidity for the hourly than for the quarter-hourly auction. Therefore, demand, solar generation and inflexible ramps of thermal power plants are hedged at the hourly day-ahead auction and use the quarter-hourly auction only to balance the remaining differences. To prove this argument the price sensitivities of the hourly day-ahead and quarter-hourly intraday auctions in Germany are compared based on actual bid and ask curves from 2015 and 2016. Finally, the development of an adequate design of future spot markets is discussed.

An Empirical Analysis of Market Efficiency and Price Discovery in Indian Commodity Market

The present article is an attempt to empirically investigate the long-term market efficiency and price discovery in Indian commodity futures market. The study has been conducted with eight commodities which include two agricultural commodities, two industrial commodities, two precious metal and two energy commodities. Sophisticated statistical methods like restricted cointegration and vector error correction model (VECM) are used to analyse the spot and futures prices time series. Restricted cointegration test shows that near-month futures prices for all the commodities are cointegrated with the spot prices but futures prices of all the commodities are inefficient to predict the future spot price. Indian commodity futures market evidenced as the thinly traded market (Kumar & Pandey, 2013, Journal of Indian Business Research, 5(2), 101–121) rejects the null hypothesis of efficiency and unbiasedness for all the eight commodities which reconfirms the result of Fortenbery and Zapata (1997, Journal of Futures Markets, 17(3), 279–301). The presence of short-term biases in the Indian futures market is evidenced in the results of VECM model which indicates the presence of informational efficiency. The statistically significant value of past prices of spot and futures confirm the short-term inefficiency and biasedness. The significant value of error correction term (ECT) of futures prices suggests that commodity futures are the most important indicator of commodity price movements. The important implication of the results is for market traders. They can use the futures prices to discover the new equilibrium and earn profits by transmitting it to the spot market. The better understanding of the interconnectedness of these market would be useful for policymakers who try to establish stability in the financial markets.

Buy now and price later: Supply contracts with time-consistent mean–variance financial hedging

We consider a two-stage supply chain comprising one risk-neutral manufacturer (he) and one risk-averse retailer (she), where the manufacturer procures consumption commodities in spot market as major inputs for production and sells the final products to the retailer. The retailer then sells the final products to the market at a stochastic clearance price. We investigate a flexible price contract that allows the manufacturer to determine the product wholesale price, and the retailer to determine the order quantity, based on the future spot price of consumption commodities. Compared with the simple wholesale price contract, a win–win situation can be achieved under the flexible price contract when the manufacturer's postponed processing cost is lower than a threshold. However, under this flexible price contract the retailer may suffer from the commodity price volatility, even if she does not procure the commodities directly. We further investigate how the risk-averse retailer conducts mean–variance financial hedging by purchasing consumption commodity futures contracts. We formulate the problem using a dynamic programming model and derive a closed-form time-consistent financial hedging policy. Through numerical experiments, we show that the commodity price risk from the manufacturer to the retailer is effectively mitigated with the hedging, and the benefits of the flexible price contract are maintained.

Forward Unbiasedness in the Short End of the Interest Rate Market

Forward rate unbiasedness postulates that the forward rate is an unbiased estimator or predictor of the future spot rate. This case of risk neutrality has been tested extensively especially in the foreign exchange market. This paper departs from this line of research and studies unbiasedness at the short end of the interest rate market. Although, a priori, an investment of 6 months and an investment of three months rolled over for an additional 3 months are commonly believed to be riskless at first approximation, our results show otherwise. The precision of our estimators unveil a small but statistically significant risk premium. The latter has two components, a constant risk premium and a time-variable one. The constant risk premium is estimated to be 14.4 basis points. The time-variable risk premium ranges between a maximum of 184.6 basis points, and a minimum of -123.2 basis points, and averages 5.4 basis points. The methodology in this paper is amenable and adaptable, with little adjustments, to other maturities. This is an agenda for the future.

Characteristics of Petroleum Product Prices: A Survey

We review and synthesize the empirical evidence on several factors related to petroleum product prices: (1) the general distributional characteristics of petroleum product prices; (2) the influence of refinery outages, extreme weather, and similar circumstances on product prices; (3) the way that price discovery occurs for petroleum products; (4) the predictive accuracy of petroleum product futures prices for future spot prices; and (5) the impact of speculation on product prices.

The relative efficiency of the crude oil futures market: evidence from India

The purpose of this study is to identify the extent of relative efficiency of the futures contracts of crude oil, traded in the multi commodity exchange of India limited. This study examines the price discovery process in the short-run and long-run by using daily data from 1 April 2006 to 30 June 2015. Stationarity and cointegration tests reveal that spot and futures prices are I(1) and cointegrated. Granger causality test has been employed to examine the short-run price discovery, which shows a bi-directional causality with a dominance of the futures market. Three different information share techniques-component share method of Gonzalo and Granger (1995), information share method of Hasbrouck (1995) and modified information share of Lien and Shrestha (2009) – have been used to measure the relative efficiency of the spot and futures market in the long-run. These results (short-run and long-run) indicate that the price discovery takes place in the futures market. Relative efficiency and the price discovery have crucial implications for optimal portfolio allocation and forecasting of future spot prices. These findings might be useful for the regulators, government, exchange and policy makers to form market structure policies and guidelines for the commodity markets in emerging economies.

The relative efficiency of the crude oil futures market: evidence from India

The purpose of this study is to identify the extent of relative efficiency of the futures contracts of crude oil, traded in the multi commodity exchange of India limited. This study examines the price discovery process in the short-run and long-run by using daily data from 1 April 2006 to 30 June 2015. Stationarity and cointegration tests reveal that spot and futures prices are I(1) and cointegrated. Granger causality test has been employed to examine the short-run price discovery, which shows a bi-directional causality with a dominance of the futures market. Three different information share techniques-component share method of Gonzalo and Granger (1995), information share method of Hasbrouck (1995) and modified information share of Lien and Shrestha (2009) – have been used to measure the relative efficiency of the spot and futures market in the long-run. These results (short-run and long-run) indicate that the price discovery takes place in the futures market. Relative efficiency and the price discovery have crucial implications for optimal portfolio allocation and forecasting of future spot prices. These findings might be useful for the regulators, government, exchange and policy makers to form market structure policies and guidelines for the commodity markets in emerging economies.