A STUDY OF FOREIGN EXCHANGE FUTURES MARKETS

Conditions for futures markets to survive have been addressed through micro analysis. In pursuit of their objectives hedgers compare the relative volatility of either futures prices or of "basis" to that of spot prices for their decisions. Speculators seek markets which present fluctuating futures prices, wide "basis", low transaction costs and many cases of uncovered interest arbitrage.;Findings of this study further suggest that even if there were not "unexpected shocks" during hedging periods, futures rates still could not be expected to be at the same level as expected future spot rates.;Empirical tests made in the study support hypotheses of randomness of error terms and normally distributed unexpected shocks in foreign exchange futures markets. Unexpected shocks in foreign exchange futures markets of three currencies with quite different characteristics were found to be normally distributed, while "expected shocks" were found to be serially autocorrelated. Therefore "total shocks" can not be assumed to be normally distributed, as most past studies have done.;The concept of market efficiency in futures markets is analyzed by comparison with similar concepts, and new test methods are suggested for avoiding ambiguity problems. Three different empirical tests of market efficiency all strongly support efficiency of futures markets for the three foreign currencies studied.;Equilibrium pricing models are examined under the assumption of utility maximization by each market agent. Empirical tests of (1) whether hedgers have paid prices higher than expected for futures contracts, and (2) whether hedgers have realized sufficient hedging benefits in real transactions, suggest that hedgers present the dominant type of market agent in foreign exchange futures markets. Another empirical test of whether the hedged ratio exhibits a positive relationship with hedging effectiveness shows mixed results.