Notional Value Effect in Futures Markets

Abstract

We examine how the notional value of futures contracts predicts the cross-section of returns within the major asset classes tracking a large number of futures contracts. We find that low notional value contracts outperform high notional value contracts within government bonds, short-term rates, commodities, currencies, and equity indexes. A diversified portfolio of the strategy delivers abnormal returns after controlling for standard asset pricing factors. The strategy is related to value and reversal factors but their explanatory power is low. Differences in liquidity explain a large portion of the cross-section of notional value, where high notional value contracts are more liquid, and subsume the reversal and value factors. Volatility risk can be a partial explanation both cross-sectionally where low notional value contracts exhibit higher volatility and across time where shocks to market volatility decrease strategy returns.

Keywords: Asset Pricing, Futures Markets, Factor Investing, Notional Value, Liquidity Risk, Volatility Risk

JEL Classification: G12, G13, G15