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Asymmetric Arbitrage and the Pattern of Futures Prices

Lien, Da-Hsiang Donald and Quirk, James P. (1984) Asymmetric Arbitrage and the Pattern of Futures Prices. Social Science Working Paper, 544. California Institute of Technology , Pasadena, CA. (Unpublished) https://resolver.caltech.edu/CaltechAUTHORS:20170918-162413469

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Abstract

Since Keynes first argued that backwardation was the normal state of affairs on futures markets, there have been several theoretical explanations for its existence. In particular, Fort and Quirk have shown that the "Houthakker effect" can lead to a backwardation equilibrium. In this paper, we consider another argument for backwardation suggested by Houthakker, namely, asymmetric arbitrage. Our conclusions are generally negative, despite its intuitive appeal. Specifically, in a world with an equal number of short and long hedgers, with identical utility functions and densities over cash and futures prices, if the futures market is a forward market, then in a rational expectations framework, asymmetric arbitrage has no effect on the pattern of futures (or cash) prices. If we are dealing with a true futures market, under the above assumptions, arbitrage will act to encourage short hedging and to discourage long hedging only under some restrictive conditions. Moreover, further quantitative restrictions must be imposed in order to derive a backwardation equilibrium under asymmetric arbitrage.


Item Type:Report or Paper (Discussion Paper)
Additional Information:This research was supported in part under NSF Grant #SES-8319960.
Group:Social Science Working Papers
Funders:
Funding AgencyGrant Number
NSFSES-8319960
Series Name:Social Science Working Paper
Issue or Number:544
Record Number:CaltechAUTHORS:20170918-162413469
Persistent URL:https://resolver.caltech.edu/CaltechAUTHORS:20170918-162413469
Usage Policy:No commercial reproduction, distribution, display or performance rights in this work are provided.
ID Code:81550
Collection:CaltechAUTHORS
Deposited By: Jacquelyn Bussone
Deposited On:19 Sep 2017 16:29
Last Modified:03 Oct 2019 18:44

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