RDP 8804: Pricing Behaviour in Australian Financial Futures Markets 7. Conclusions

The paper began by identifying two major sets of issues which have been raised in the study of financial futures markets outside Australia. The first of these concerns the hypothesis of market efficiency, which asserts that futures prices fully reflect available information about future spot prices. Efficiency in this sense is regarded as an important minimal requirement if futures markets are to fulfil their economic functions as instruments of inventory and risk management. The paper has assembled evidence on the efficiency of each of the three main futures markets in Australia, and in general the efficiency hypothesis is found to be supported by the data.

The one clear exception to this result concerns the pre-crash behaviour of share prices. SPI futures were found to have a significant positive drift, which is inconsistent with market efficiency because it indicates significant excess profits to holders of long positions prior to the crash. Conversely, short positions lost money on average. A possible means of reconciling this behaviour with investor rationality is the conjecture that the pre-crash period contained a speculative bubble in share prices, which investors expected would burst at some uncertain future date. Under this hypothesis, expected returns would be zero in an ex ante sense throughout the period, but would appear positive in sub-periods which exclude the crash. This conjecture has not yet been rigorously tested, but it appears a more promising approach for understanding the pre-crash period than explanations based on risk aversion or on mistaken expectations, which would be the main alternatives.

The second major issue concerned the question of whether or not futures trading has a statistically detectable influence on the short-term variability of spot prices. Here the results are quite clear in rejecting a causal link from futures trading volumes to spot price volatility. One easily verified aspect of this result is that there has been no trend increase in spot market volatility during the past three years, despite spectacular growth in futures trading.

This does not, however, mean that futures markets have no influence at all. There is strong evidence that futures price movements tend to lead movements in the corresponding spot prices, with the estimated lead time being possibly as long as one or two weeks.^[4] It would be difficult to interpret this relationship as causal in the usual sense, but it could be argued that futures prices perform a signalling role, reacting relatively quickly to new information, which then becomes reflected in spot prices with a short lag. This interpretation is consistent with theory, which suggests that the signalling role is likely to be performed by the market with the lower transaction costs. In this sense, the futures markets could be seen as being more efficient than the spot.

As a final point, it should be reiterated that the paper has adopted a relatively limited working definition of market efficiency, based on the predictive content of futures prices over spot prices. Although the futures markets have been found to be generally efficient by this criterion, nothing in the paper can be taken as ruling out more deep-seated forms of inefficiency involving sustained departures of spot prices from market fundamentals.

Footnote

In the case of bill futures, this result may in part be explained by the different time period covered by a futures bill as against a spot bill, since investors' views about the two periods may differ. [4]