The two patterns of futures prices are known as the `normal backwardation' and the `contango'. This paper only talks about the `normal backwardation', and will firstly explain the definition, and then, will discuss briefly about the empirical evidences and the debate on it.
Normal backwardation was firstly introduced by John Maynard Keynes in his `Treatise on Money' (1930), as he argued that the normal backwardation, is the expectation that futures prices will rise over the contract life, as a reward to risk-assuming speculators which is paid for by risk-averse net short hedgers--should prevail for commodity futures. (Richard Deaves and Itzhak Krinsky, 1995)
We have an example here, an apple farmer takes a long position in apple, because he grows and owns the apples, here the farmer is the hedger, and hedgers usually more risk-averse than the speculators, thus this farmer would like to sell apple futures to reduce his risk, then he is net short. If the hedgers are net short, the speculators must be net long, and the speculators only take this long position when they expect the future spot price of apples is higher than the current apple futures. As a result, the farmer (hedger) passed his risk to speculator, as he bought insurance from the speculator by paying an expected profit to the speculator to bearing the risk. (However, this profit for speculator is not sure, as `the speculators are able to demand a premium only if their positions are correlated with the return on a properly defined market portfolio.' (Richard Deaves and Itzhak Krinsky, 1995))
If the speculators' expectation is correct, then the futures price must below the expected future spot price, under this situation, the futures prices are expected to rise ov...
... middle of paper ...
...ore positive forecast error than negative; hence, the finding of positive mean returns.' (Richard Deaves and Itzhak Krinsky, 1995)
To sum up, nearly equal numbers of studies support and oppose Keynes' idea of "normal backwardation." It is really not easy for us to analyse due to the use of different statistical tools and the fact that futures returns are very near zero.
Bibliography:
Deaves, R. and Krinsky, I. (1995) Do Futures Price for Commodities Embody Risk Premiums? The Journal of Futures Markets (1986-1998); Sep, 1995; 15,6; pg637
Hull, J.C. (2002) Fundamentals of Futures and Options Markets. Prenctice Hall, Fourth Edition.
Kolb, R.W. (1992) Is Normal Backwardation Normal? The Journal of Futures Markets (1986-1998); Feb, 1992; 12,1; pg75
Kolb, R.W. (1997) Understanding Futures Markets. Blackwell, Fifth Edition.
If it can be determined that the depressed prices for lean hogs are only temporary, inventories could and should be kept at cost basis. In this case, adjusting prices to match current market prices would not be necessary. Future prices indicate a recovery before the end of the fiscal year. Futures prices will surpass cost in February and remain above cost for the remainder of the fiscal year. The future prices support claims that the price fluctuations are only temporary in nature, and do not reflect a permanent downward shift in hog prices. Since inventories once impaired cannot be marked up to reflect changes in market conditions, this strategy could be beneficial to the company later on. In this case inventory would not be shown on the books at an unfairly low value.
Keynes and Hayek represent different options. Should we steer markets or set them free? “Which way should we choose, More bottom up or more top down?” (Fight of the Century). These questions reflect the opposite ways Keynes and Hayek address the economy. Keynes wants to “steer” the economy from the “top down.” From his understanding of the economy, Keynes theorizes that the market can be directed by those with the power to do so to accomplish goals leading to a prosperous economy. This is the basis in his approach to dealing with recessions where the government or central bank manipulates the economy. The other side is a free market from the “bottom up” on which Hayek stakes his claim. Instead of steering the economy, Hayek proposes to leave it alone. Do not try to control it, but let the market determine the interest rate and price level, as it eventually will, through supply and demand. In this way, control is not exerted downward, but reality is expressed from basic economic forces. Fundamentally, Keynes’s model focuses more on the spending and consumption aspects of GDP, and Hayek’s approach focuses more on the investing aspect which flows from saving. These are the options from which to choose. Keynes vs. Hayek, Short run vs. long run, controlled vs. free, top down vs. bottom up, each possibility has its negatives and positives. This debate is not wrapped up
Williams, James L. "Crude Oil Futures Prices - NYMEX." WTRG Economics. 01 Apr. 2011. Web. 02 Apr. 2011. .
Pennings, Joost M.E. Research in Agricultural Futures Markets: Past Present and Future. Presentation Paper: Wageningen Agricultural University: Netherlands. 8 June 2001.
Other economic theory must be developed to address some of the shortcomings of the Keynesian economic principles.
A traditional analysis gives a mistakenly high value to dollars in the future, money in the future is given the same value as money today; but in reality, money in the fu...
Keynesian Economics was developed and founded by John Maynard Keynes. He believed and wrote in his book “The General Theory of Employment, Interest and Money” that it is essential for the Government to play a vital role in economic stability. Keynesian theorists believe government spending, tax hikes and tax breaks are vital to economic success. Keynesian assumptions include: Rigid or Inflexible Prices, Effective Demand, and Savings-Investment Determinants. Rigid or Inflexible Prices suggest that wage increases are easier to take while wage decreases hit resistance; likewise, a producer will increase prices yet when needed will be reluctant to decrease prices.
Finance theory does not provide a complete framework for explaining risk management under the fluctuated financial environment in which firm operates. Hence, for corporate managers, they rank risk management as one of their top priorities. One of the strategies to reduce risk is by hedging. This paper will discuss the advantages and disadvantages of hedging risk using financial derivatives.
The theory of economics does not furnish a body of settled conclusions immediately applicable to policy. It is a method rather than a doctrine, an apparatus of the mind, a technique for thinking, which helps the possessor to draw correct conclusions. The ideas of economists and politicians, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist." (John Maynard Keynes, the General Theory of Employment, Interest and Money p 383)
Roll, R. & Ross, S.A.(1980).An empirical investigation of arbitrage pricing theory. Journal of Finance, 35(5), 1073-1103.
...hould accept the inconvenient truth that the markets sometimes do not function properly. Second, economists should re-embrace Keynesian practice because it does offer a legitimate answer for economic downturns. Finally, they should consider the realities of finance in the world of macroeconomics (Krugman 2009). As an upcoming economist from George Mason, primarily a “freshwater” school, I find the first suggestion a bit difficult for me to accept. I think the best option right now is to stay neutral and open-minded because I still have a lot to learn about economics.
of USD, it would need to put more weight in long futures contracts as much as they believe in by
Chapter 11 closes our discussion with several insights into the efficient market theory. There have been many attempts to discredit the random walk theory, but none of the theories hold against empirical evidence. Any pattern that is noticed by investors will disappear as investors try to exploit it and the valuation methods of growth rate are far too difficult to predict. As we said before the random walk concludes that no patterns exist in the market, pricing is accurate and all information available is already incorporated into the stock price. Therefore the market is efficient. Even if errors do occur in short-run pricing, they will correct themselves in the long run. The random walk suggest that short-term prices cannot be predicted and to buy stocks for the long run. Malkiel concludes the best way to consistently be profitable is to buy and hold a broad based market index fund. As the market rises so will the investors returns since historically the market continues to rise as a whole.
Ferguson, S (1999) Keynesian Theory and its implication, College of Management and Economics, Canada University, 298-312