The Economic Value of Linkages between Spot and Futures Market

29 Pages Posted: 17 Mar 2008

See all articles by Devraj Basu

Devraj Basu

SKEMA Business School - Lille Campus

Alexander Stremme

University of Warwick - Finance Group

Multiple version iconThere are 2 versions of this paper

Date Written: February 29, 2008

Abstract

In this paper we study the economic value of predicting the equity risk premium using market variables that reflect the positions of traders in futures and derivatives market. The economic value is ascertained by studying the performance of market timing strategies that use the positions of commercial hedgers and small speculators as predictive variables. Our market timing strategies have high positive Sharpe ratios over the 1999-2007 period compared to a Sharpe ratio of almost zero for the market index. They avoid losses during major downturns and have significant positive alphas, in contrast to timing strategies based on business cycle variables which under-perform the index over this period. The predictive ability seems to originate from a delayed response to changes in fundamentals for large speculators and from herding among small investors. Overall these results indicate that market variables could play an important and economically significant role in predicting the equity risk premium.

Keywords: Return Predictability, Hedging Pressure, Timing Strategies

JEL Classification: G11, G12, G15

Suggested Citation

Basu, Devraj and Stremme, Alexander, The Economic Value of Linkages between Spot and Futures Market (February 29, 2008). WBS Finance Group Research Paper No. 92, Available at SSRN: https://ssrn.com/abstract=1099839 or http://dx.doi.org/10.2139/ssrn.1099839

Devraj Basu (Contact Author)

SKEMA Business School - Lille Campus ( email )

Avenue Willy Brandt, Euralille
Lille, 59777
France

Alexander Stremme

University of Warwick - Finance Group ( email )

Gibbet Hill Rd
Coventry, CV4 7AL
Great Britain
+44 (0) 2476 - 522 066 (Phone)
+44 (0) 2476 - 523 779 (Fax)

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