The predictability of futures returns: rational variation in required returns or market inefficiency?

This paper investigates whether the predictability of futures returns is due to weak-form market inefficiency or to rational variation in the return required by investors over time. Market efficiency is tested with respect to the hypothesis that a conditional multifactor model that allows for shifts in the systematic risk of the futures contract captures the predictability of futures returns. On average 86% of the predictability of futures returns is explained in terms of conditional risk and only 12% of the predictable variance of returns is relegated to the conditional residuals. It follows that the predictability of futures returns most likely results from rational variation in the preferences of economic agents for consumption and investment.