Education of students, clients, and colleagues about futures and options markets, through classroom teaching and supported scholarly research, remains the principal objective of the Office for Futures and Options Research (OFOR) at the University of Illinois at Urbana-Champaign (UIUC). Established in 1993, OFOR looks back with pride at its accomplishments, and looks forward to the challenges forthcoming into the next century.
The UIUC is the leading university in the country in educating and placing students in the futures industry. We educate 300 to 500 students annually about futures and options markets in undergraduate, MBA, and graduate classes. Much of this activity is centered in OFOR. In addition to classroom instruction, OFOR has published 24 working papers, two conference proceedings, and one book (listed inside this newsletter). OFOR has also published a world-class homepage with numerous national and international linkages. This address is given below.
We have created a practical computerized hedging simulator, HedgeSim, and are currently programming a realistic futures and options trading simulator, TradeSim. HedgeSim will soon be available for purchase; information is given inside this newsletter. TradeSim will be available for beta testing with futures contracts on the Internet in spring 1997. OFOR has raised $134,000 to support TradeSim, but more funds and programming time are needed to complete the project.
This OFOR Exchange features summaries of scholarly research by one of our OFOR associates, Professor Philip Garcia, and the research conducted by our most recent graduate students for their theses or dissertations. Lists of working papers and recent OFOR associate publications denote additional research done by faculty and students affiliated with OFOR. Donors to OFOR are listed inside along with an indication of recent awards by OFOR personnel. Please share this OFOR newsletter with anyone you believe would have an interest and enjoy it. Also, visit our homepage site: index.html
Raymond M. Leuthold
Director
Professor Philip Garcia's research focuses on how information affects and is processed in commodity and futures markets; specifically, the research has examined three areas.
Market Efficiency
Futures markets generate information on forward prices that producers and marketing firms use in making production, marketing, and inventory decisions. If prices do not appropriately reflect supply and demand conditions, resources may be misallocated and welfare reduced.
Professor Garcia has examined the pricing efficiency of several agricultural livestock and grain markets. Early work on the live hog and live cattle markets suggested the importance of considering not only the forecast accuracy of these markets in a statistical sense, but the returns which can be generated from the forecasts. Overall, the findings suggest that grain markets and cattle markets are relatively efficient forecasters of subsequent prices, but that the live hog contracts, particularly at more distant horizons, do not incorporate available information.
More recent market efficiency work indicates that the corn and soybean markets are influenced by the unanticipated component of the USDA reports, and that the new information is quickly incorporated into prices. In addition, examination of the daily returns of large traders over a nine-year period in the frozen pork bellies futures market indicated that the distribution of returns was not random. For an elite subset of the largest traders, significant profits were positively related to the traders' ability to forecast price behavior. Current work examines the effect of increased uncertainty about the USDA reports on the price discovery process, the ability of large pork belly traders to effectively anticipate USDA inventory reports, and the relative forecast accuracy of the harvest corn and soybean futures markets at planting.
Cash and Futures Price Relationships
Examination of the dynamic behavior of futures and cash prices from important spot corn, soybean, hogs, and cattle markets has identified the importance of the futures market in the price discovery process. Generally, futures prices are the focal point of the assimilation of market information. Price information is rapidly transmitted to elevators and terminal markets. However, nonterminal cattle markets often demonstrate a high degree of interaction or feedback with the futures market such that their information also influences the behavior of the futures prices.
Dr. Garcia's early work in understanding and forecasting basis patterns identified the structural factors which influenced the behavior of basis risk in corn, hog, and cattle markets. More recent work has focused on generating forecasting procedures for basis relationships for soybeans, hogs, and cattle. The findings suggest that straightforward time series procedures and market-derived forecasts provide the most accurate and timely assessments of basis movements. In a related context, concern over the decline in trading volume and perceived increase in basis risk in the live hog contract led Dr. Garcia to further investigate its basis predictability over time. Contrary to concerns, the research identified that the ex ante basis risk has not increased over the last eight years, and consequently that the decline in contract trading volume is not associated with increasing basis uncertainty.
Marketing Strategies
Dr. Garcia has examined the usefulness of alternative marketing strategies when combined with forecast information in the presence of options and under alternative risk preferences. The thrust of the inquiries has been to identify the value of forecast information in the presence of options, the usefulness of conventional mean-variance procedures for identifying the optimal strategies in the presence of truncated returns distributions, and the existence of robust marketing strategies that are insensitive to price uncertainty and the structure of risk preferences.
The findings suggest that forecasters should concentrate primarily on mean as opposed to variance forecast accuracy, that mean-variance optimal strategies are still useful alternatives in the presence of options, and that the robust strategies are available. Other work has estimated and examined the usefulness of time-varying hedging ratios, and the continued attractiveness of alternative strategies in the live hog contract when combined with forecasting procedures.
Philip Garcia is a professor in the Department of Agricultural and Consumer Economics at the University of Illinois at Urbana-Champaign (UIUC). He received his B.A. in economics at Occidental College (1968), and his M.S. (1975) and Ph.D. (1978) degrees in agricultural economics from Cornell University. Dr. Garcia's research has been published in leading academic journals, including the American Journal of Agricultural Economics, International Economic Review, Journal of Business, and the Journal of Futures Markets. He also has served as senior associate editor for the American Journal of Agricultural Economics, and currently is on the editorial board of the Journal of Futures Markets.
OFOR is funded by an endowment created by the original donors and by additional contributions from alumni and friends. Funds are used to support OFOR's research projects; maintain futures market databases; host conferences, seminars, and lectures; publish working papers and conference proceedings; and sponsor visiting scholars.
Multiple alternatives exist for financial participation in support of OFOR activities, such as contribution to the OFOR Enrichment Fund. Pledges or gifts to OFOR can be designated to support undergraduate student fellowships, OFOR research assistantships, visiting academic scholars, and industry fellows. Naming opportunities exist for all of these activities and categories.
Up to $100
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OFOR recognizes and acknowledges the original endowment and continued support provided by Gary and Carlotta Bielfeldt and their family through the Bielfeldt Foundation of Peoria, Illinois.
Outstanding Ph.D. Dissertation, 1995
Department of Agricultural and Consumer Economics
University of Illinois at Urbana-Champaign
Dwight R. Sanders, "Noise Trader Sentiment and the Behavior of Futures Prices." October 1995.
Publication of Enduring Quality, 1996
American Agricultural Economics Association
Thomas A. Hieronymus, Economics of Futures Trading. New York: Commodity Research Bureau, Inc., 1971.
Available Now. Cost: $20
OFOR is proud to announce the publication of a book featuring a set of writings by Emeritus Professor Thomas A. Hieronymus entitled A Revisionist Chronology of Papers by T.A. Hieronymus: A Consistency of Biases. This compilation consists of 43 papers dating from 1950 to 1993.
Most readers will not have seen many of these writings. They represent a wide range of material, including speeches, Extension materials, conference presentations, journal articles, and congressional testimony. Several deal with agricultural policy, especially policy related to soybean prices and production. Some papers are very basic to futures markets, such as how to hedge, futures markets and financial equity, definition of hedging, designation of delivery points, and a definition of manipulation. Additional papers demonstrate how Professor Hieronymus educated Congress about futures markets and speculation over several years. Professor Hieronymus also includes papers in which he instructed the Chicago Board of Trade to get its act together; told Midwest elevators to "get good or get out"; presented speeches on controversial topics in New York; advocated cattle futures in front of a reluctant meat industry before these contracts were introduced; and repeatedly called for the government to stay out of agricultural markets. Research ideas run through many papers, especially advocating research on the role and quality of speculation.
These papers are challenging, interesting, and entertaining. They show clearly Professor Hieronymus's significant influence, not only on the futures industry but also on agricultural policy. They demonstrate depth and breadth of expertise, and consistent advice about policy, markets, prices, and trade.
Business managers, traders, and others can host a UIUC undergraduate for one day at their place of work and share with the student their work atmosphere and procedures. We ask no more of you than your time and talent to mentor a UIUC student. Simply contact the OFOR office and indicate your business specialty and the academic background you desire of a visiting participant. We will select a student who will then contact you. The student assumes responsibility for all arrangements, transportation, and expenses.
Jennifer Reinhart
Jennifer Reinhart met with the general manager of Roanoke Farmers' Association, Terry Bline. Terry is responsible for all of the merchandising, operations, and overseeing of employees. Roanoke Farmers' Association is unique because it is the only local facility that can hold up to six million bushels of grain. The elevator is organized very efficiently so farmers can get their grain in, dump it, and leave quickly. New technology has improved efficiency and convenience. Many customers have their own DTN system, allowing more efficiency in the buying and selling of grain. In conjunction, an in-house marketing program is available for the farmer customers. By working together, the farmers will have a better understanding of how the futures market works. This improved understanding benefits both the cooperative and the farmers. Terry indicated that he would like to see more of the younger generation enter farming.
Tammy Kurtenbach
Tammy Kurtenbach spent the day with Dan Cekander of FIMAT Futures USA, Inc. When she arrived, Dan was already on the phone with one of his clients. They were discussing how the weekend weather was going to influence the grain market and what would be good trades. In fact, most of Dan's mornings are spent on the phone giving or obtaining market information. Early each morning, Dan participates in a conference call with FIMAT clients and brokers discussing the outlook for the market for that day. Throughout the day, Dan also takes orders for his accounts and phones them into FIMAT's desk on the floor of the Chicago Board of Trade. Dan generally reserves his afternoons for "number work." He researches current market and crop conditions and arrives at numbers which represent his expectations of the market. He uses these numbers for the outlook report and to keep on file as a resource.
Keith Bollman
Assistant Commodity Analyst Meat Department, Topco Associates
Skokie, Illinois
Keith Bollman's thesis investigates the price relationships between diammonium phosphate (DAP) cash and futures prices to evaluate pricing and risk management in the fertilizer industry, the potential demand for hedging within the industry, and the price linkages through the market system. The results indicate poor market integration among the DAP cash and futures markets. The results also show the current DAP futures contract behaves as a forward contract with a high rate of delivery causing the contract to be a poor hedging tool.
Li Yang
Assistant Professor School of Banking and Finance, University of
New South Wales
Sydney, Australia
Li Yang's dissertation examines the reaction of the frozen pork bellies futures market to the release of inventory information. Knight-Ridder releases their analysts' forecasts of the USDA estimate two days prior to the inventory numbers provided by the USDA. A three-period rational expectations model is developed to study how futures markets react to the information release. It is shown theoretically that previous studies of price reaction based solely on the information content of the difference between the USDA estimate and the average of analysts' forecasts may induce measurement error when the magnitude of the disagreement among analysts is large and the performance of the average of forecasts is poor. However, the evidence supporting the importance of incorporating the dispersion of analysts' forecasts is mixed. When analysts' forecasts are an unbiased estimate of the USDA report and the disagreement among analysts is small, measurement error is small.
Fabio Zanini
Ph.D. Candidate, University of Illinois
Urbana, Illinois
Fabio Zanini's thesis investigates the attractiveness of hedging opportunities in the live hog futures using forecast information. Results indicate that the live hog contract offers producers attractive pricing opportunities using selective hedging strategies and forecast information from January 1987 through December 1993. However, consistent with previous research findings, the average price from the routine hedging is almost $3.00 lower than a cash-sale strategy. This suggests that producer returns are dramatically affected by the type of strategy selected and the price forecasting procedure used. Findings here indicate that the live hog contract continues to offer producers attractive pricing opportunities, and suggests that the success of the new lean hog contract may depend on its ability to attract trading volume from outside the traditional production sector. Failure to attract alternative sources of trading volume may limit the success of the new contract.
Mark Ditsch
Commodity Analyst, Consolidated Grain and Barge Co.
Mound City, Illinois
Mark Ditsch's thesis examines the lean hog futures contract which is replacing the live hog futures contract at the Chicago Mercantile Exchange beginning with the February 1997 contract. The lean hog futures will be cash settled, based on a broad-based lean hog price index, eliminating terminal markets from the price discovery process. Using this index over a twenty-month period as a proxy for the lean hog futures price, this study compares the hedging effectiveness of the live hog futures contract to the hedging potential of the lean hog futures contract for cash live hogs as well as for cash meat cuts. Frozen pork bellies futures are also examined for the cash meats. The results show that the lean hog futures should perform better than either the live hog or the frozen pork bellies futures as a hedging instrument for Omaha cash hogs and cash loins. The strongest evidence of this is for the short-term hedging of cash hogs. For the other three meats, no futures contract demonstrates a clear hedging advantage.
Anning Wei
Agricultural Economist, The World Bank
Washington, DC
Anning Wei applies three nonlinear dynamic models, ARCH- type, long memory, and chaos, to the futures markets of corn, soybeans, wheat, hogs, coffee, and sugar. For the observed time-varying volatility, long-range dependence, and excessive skewness and kurtosis in those markets, it is found that the long-memory model could largely explain the sugar market, but chaos offers explanation of price behavior for the other five markets. The ARCH-type model fails in all cases. This study provides new explanations and measurements for the nonlinear dynamics in futures markets, which could be valuable inputs to investment decisions.
Keith Boris
Market Analyst, Chicago Mercantile Exchange
Chicago, Illinois
Keith Boris's thesis investigates technical analysis trading systems that have been found to produce statistically significant profits in foreign exchange markets. Several researchers have suggested that central bank interventions provide profitable opportunities to those traders willing to bet against them and are the source of the significant profits produced by technical analysis trading systems. Using a Cumby-Modest market-timing test to quantify the predictability of the channel trading rule, run in the German Deutschemark and Japanese Yen IMM futures, this study analyzes the relationship between the predictability of the channel rule and both the presence and direction of U.S. Federal Reserve foreign exchange interventions. This study shows that the market-timing ability of the channel rule is dependent on the presence of Federal Reserve interventions and specifically interventions against the direction of channel rule trades.
Mina Kim
Ph.D. Candidate, University of Illinois
Urbana, Illinois
Mina Kim's thesis examines the distributions and the independence hypothesis of changes in futures price spreads for corn, live cattle, gold, and Treasury bonds. Except for gold, this study demonstrates that the distributions of these spreads converge to normality when differencing intervals are widened from daily to weekly. Also, this study finds that the distribution of futures prices and of carrying costs has no impact on determining the futures price spreads. Implications are drawn about market efficiency.
OFOR has two creative simulation packages, HedgeSim and TradeSim. HedgeSim is a computer-based simulator, which allows students to gain experience in hedging and risk management as a farm enterprise manager. Products featured in the simulator include corn, soybeans, wheat, cattle, and hogs. Using data from 1980 to 1990, this sophisticated computer program allows students to hedge with both futures and options contracts. Students are given production cost information and government market reports, and view actual historical prices one day at a time to make appropriate marketing and pricing decisions. This program, which will soon be available for purchase through the OFOR office, can be loaded into individual computers and used in a local area network.
At the same time, OFOR is creating a trading simulator of futures and options markets called TradeSim, which is designed to be used in conjunction with the classroom. This program will be on the Internet and available to classes worldwide. It will allow students to view futures and options prices and trade contracts any time during the day, with slight time delays from the real markets. This simulator will be beta tested during this current academic year and is planned to be available for classes in either fall 1997 or spring 1998.