AbstractsBusiness Management & Administration

Efficiency, Risk Premiums and Information Diffusion in Futures Markets: International Evidence

by Duminda Kuruppuarachchi

Institution: University of Otago
Year: 0
Keywords: Futures; Market Efficiency; Risk Premium; Information Diffusion; Kalman Filter; Principle Component Factors; Granger Causality
Record ID: 1315488
Full text PDF: http://hdl.handle.net/10523/5618


My thesis investigates three major issues related to futures markets namely, market efficiency, risk premium, and information diffusion in futures. This thesis makes a significant contribution to the existing literature of futures markets in several ways. First, it introduces a novel market efficiency test in the presence of a time-varying risk premium. Second, it introduces a new market efficiency index based on the proposed efficiency test to measure the degree of efficiency of futures markets. Third, it estimates and extensively investigates futures market risk premiums. Fourth, it introduces a new common factor to explain variations common to a cross section of futures returns. The empirical analysis in this thesis is based on a comprehensive sample of 202 futures traded on 36 exchanges globally that represent six market sectors over the period 2000-2011. The impacts due to the recent financial crisis periods are also analysed in my thesis. Chapter 1 of this thesis demonstrates the background and research questions, motivations, objectives, and contribution. Chapter 2 is dedicated to explain the fundamentals of futures markets. In chapter 3, I introduce a new efficiency test for futures markets that accounts for time-varying risk premium and conditional heteroscedasticity of spot prices. Such a test does not exist in the literature. Using a Monte Carlo simulation, I demonstrate that the proposed test is superior to the conventional approaches in the literature. The test is used to analyze the efficiency of crude oil, corn, copper and gold futures and finds that gold is inefficient during the entire period 2000-2011 while the others are efficient after the global financial crisis (GFC) in 2008. Moreover, I find a significant impact on risk premiums of the four futures contracts due to the GFC where both the size and the volatility of the premiums have been increased. Chapter 4 introduces the new market efficiency index which is based on the efficiency test introduced in chapter 3. This efficiency index is based on the price information corresponding to a series of lagged time points prior to the maturity of a contract unlike in a traditional efficiency test which is normally based on the information of a single lagged time point. An efficiency test finds whether a market is efficient or not, whereas the efficiency index can be used to quantify the degree of price efficiency of a futures market. The proposed efficiency index uses a kernel based weighting method where the weights are decreased over the time lags towards the maturity to reflect the importance of the price information. This index is used to examine the market efficiency of 202 futures from energy & fuel, precious metals, industrial materials, and agricultural & live stock markets during 2000-2011. An extensive comparison of both efficiency and risk premiums across market sectors, exchanges, and regions is done. As a result, I find that the market sector as a key factor for varying risk premiums but not for the market efficiency. Futures exchanges and…