An Application of Arbitrage Pricing Theory to Futures Markets: Tests of Normal Backwardation

The Journal of Futures Markets, Vol. 7, pp. 21-34, 1987

14 Pages Posted: 29 Jul 2011

See all articles by Michael Ehrhardt

Michael Ehrhardt

University of Tennessee, Knoxville - Department of Finance

James V. Jordan

National Economic Research Associates

Ralph A. Walkling

Drexel University - Lebow College of Business

Date Written: 1987

Abstract

Keynes (1923) and Hicks (1939), hypothesized that futures prices are downward biased estimates of expected spot prices. Any empirical study that employs returns on futures contracts is actually a joint test of both the Keynes-Hicks hypothesis and of the assumed model of returns. Models based on the Capital Asset Pricing Model have been used to test the hypothesis, with different models implying different conclusions. As shown in this article, these models are all special cases of a general linear model. Arbitrage Pricing Theory provides the most powerful test for this class of linear models. No other linear model will provide greater explanatory power or account for more systematic risk. An Arbitrage Pricing Theory model is estimated in this article and the results appear inconsistent with the Keynes-Hicks hypothesis.

Suggested Citation

Ehrhardt, Michael and Jordan, James V. and Walkling, Ralph August, An Application of Arbitrage Pricing Theory to Futures Markets: Tests of Normal Backwardation (1987). The Journal of Futures Markets, Vol. 7, pp. 21-34, 1987 . Available at SSRN: https://ssrn.com/abstract=917873

Michael Ehrhardt (Contact Author)

University of Tennessee, Knoxville - Department of Finance ( email )

Knoxville, TN 37996
United States

James V. Jordan

National Economic Research Associates ( email )

1255 23rd Street, NW, Suite 600
Washington, DC 20037
United States
202-466-9263 (Phone)

Ralph August Walkling

Drexel University - Lebow College of Business ( email )

LeBow College of Business
Philadelphia, PA 19104
United States
(215) 895-4920 (Phone)
(215) 895-6119 (Fax)

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