The Informational Content of Distant-Delivery Futures Contracts
Schnake, Kristin N., Karali, Berna, Dorfman, Jeffrey H., Journal of Agricultural and Resource Economics
Futures markets have two main goals: price discovery and risk management. Because management decisions often have to be made on a time horizon longer than the time until expiration of the nearby futures contract, it is important to determine how well distant-delivery futures contracts are able to assist in price discovery. We focus on soybean and live cattle distant-delivery futures contracts and test for the informational value added to nearby contracts. Two tests for information value provide partially conflicting results due to the different information measures employed. If being able to predict the price trend is sufficient, then we find some information value in distantdelivery futures contracts, while if accurate point estimates of future spot prices are desired the results are negative. Surprisingly, we do not find the expected dichotomy between the storable (soybeans) and non-storable (cattle) commodities.
Key words: distant-delivery contract, futures markets, price discovery
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One of the main goals of futures markets is price discovery. Price discovery is driven by producers, speculators, processors, consumers, governments, etc. Having accurate forecasts of prices one, three, five, or more months into the future is vital for profitable production decisions, purchases, and planning. Therefore, analyzing futures prices to determine whether distant-delivery contracts contain informational value for price discovery is essential. After all, if distant-delivery futures prices are just random modifications to nearby contracts, then deferred futures are arbitrary and price discovery is ineffective.
Producers and consumers use the risk management feature of futures markets in order to hedge price risk by taking a futures position opposite of their cash market position. Farmers often use distant-delivery futures contracts because of the time to harvest for commodities such as soybeans and the biological lag of livestock such as cattle. For example, a feedlot might use distant-delivery contracts to lock in prices several months before their cattle are ready for market, or on the input side to guarantee the cost of corn for use as feed. Agribusinesses rely on distant-delivery futures to provide accurate forecasts of future input prices and use those contracts to manage their input cost risk through hedging when they deem that appropriate. Speculators play a major role in price discovery and help producers hedge their risk through their willingness to take opposite positions and thus provide liquidity. If futures prices are price forecasts then they provide an estimation of the supply and demand conditions in the future. The question is how far into the future an individual can look to use futures prices and still obtain valuable information. We ask whether or not distantdelivery contracts actually incorporate additional information beyond the nearby contract or are merely random adjustments.
Henriksson and Merton (1981) proposed a nonparametric test to explore the informational content of any set of forecasts. The Henriksson-Merton test is based on whether a set of forecasts can predict directional changes better than a naïve forecast model. Thus, informational content in futures contracts implies that those futures prices can predict the direction of price movement (increase or decrease) either between the nearby contract's expiration date and now or between a distantdelivery contract's expiration date and a more nearby contract. One could think of the Henriksson- Merton test as a test for the ability to time a market using the information in some set of forecasts; in this application the forecasts are futures prices. Pesaran and Timmermann (1994) modified the Henriksson and Merton test to a generalized form, allowing for more than two categories of forecast outcomes.
Vuchelen and Gutierrez (2005a) proposed a direct test that looks specifically at forecast optimality and the informational content of multiple horizon forecasts compared to the last observation. …