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The predictive performance of the currency futures basis for spot returns

Liyan Han, Xue Jiang and Libo Yin

Quantitative Finance, 2019, vol. 19, issue 3, 391-405

Abstract: This paper investigates the predictive performance of the futures basis in directly forecasting currency spot returns and compares it with that of the one-month forward basis. We consider the settle prices of both front-month and nearby-month continuous futures contracts and find that the futures basis exhibits statistically and economically significant in-sample and out-of-sample forecasting power, which clearly exceeds that of the well-known forward basis. The empirical results show that spot returns correspond negatively to both the front-month futures basis and nearby-month futures basis. Furthermore, the futures basis reveals substantial economic value for investors in terms of sizable and tangible portfolio gains, which are consistent with statistical measures. The difference in the forecasting ability of the futures basis and forward basis can be explained by the level of exposure to the time-varying risk premium. Finally, we find that impacts of the futures basis on spot returns vary with time and experienced substantial structural changes during the Global Financial Crisis.

Date: 2019
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