Daily Trading and Efficiency in Futures Markets

This study examines short horizon currency futures returns. Expectations hypothesis or risk neutrality assumes an efficient market with no risk premium, and therefore no predictor for futures returns. Using the British, German, Swiss, Japanese, and Canadian currencies as well as pooled currency data, we document that in the 1980s the futures-spot basis was a proxy for the risk premium and did have predictive power over futures returns. However, in the 1990s, various efficiency enhancing mechanisms have reduced the risk premium and eliminated the forecasting power of the basis. Conclusions are similar and even more pronounced for longer maturity currency futures contracts where the risk premium was more dominant in the 1980s