The pricing relationship of eurodollar futures and eurodollar deposit rates

✍ Scribed by Hung-Gay Fung; Wai K. Leung

• Book ID: 102842787
• Publisher: John Wiley and Sons
• Year: 1993
• Tongue: English
• Weight: 678 KB
• Volume: 13
• Category: Article
• ISSN: 0270-7314
• DOI: 10.1002/fut.3990130202

✦ Synopsis

Garbade and Silber (1983a)

, among others] have analyzed the price discovery function of various futures markets. Their results generally support the view that the futures market provides useful information to forecast spot market price movement.

This article examines the pricing relationship of Eurodollar futures and Eurodollar time deposit rates for the period 1983-1990. In particular, the price discovery function of the Eurodollar futures market is tested. The analysis is of interest for several reasons. First, economic theory asserts that forces tend to keep a pair of economic series together over time. Futures and cash market prices are good examples of such an economic time series. One would expect that a predictive relationship may exist between these two markets.

Futures and spot prices have been shown to be nonstationary [e.g., Goldenberg (1989); Doukas and Rahman (1987); and Schwert (1987)l. Thus, many prior studies use the first difference of the futures prices or other measures, such as the difference between futures and spot prices, to account for nonstationarity in regression or vector autoregressive (VAR) models. For testing the relationship between nonstationary variables, the more appropriate analysis is the cointegration methodology because the VAR model is misspecified [Engle and Granger (1987);Granger (1986)]. In fact, Granger (1986) suggests that futures and cash prices are cointegrated. A recent study by Bessler and Covey (1991) uses the cointegration method to analyze the U.S. cattle futures and cash markets.

The authors would like to thank Sanjay Nawalkha, the two anonymous referees for valuable comments, 'Other important functions of the futures market include risk transfer (via hedging) and aribitrage (that and Nancy Jackson for editorial assistance. corrects mispricing behaviors in both futures and cash markets).