THE USEFULNESS OF TREASURY BILL FUTURES FOR FORECASTING AND HEDGING

This thesis outlines methods for evaluating the usefulness of a futures contract for forecasting and hedging and applies them to the 91-day Treasury bill futures contract traded on the International Monetary Market of the Chicago Mercantile Exchange.;The thesis also examines the validity of the rational expectations hypothesis as an interpretation of the forward prices for 91-day Treasury bills which are implicit in the prices of spot Treasury bills. Again, the hypothesis is not rejected. While the two prices are not identical throughout the sample period, they are very highly correlated and their means are not significantly different.;An analytical framework for evaluating the usefulness of a futures contract for hedging is developed that integrates the existing literature on hedging with the literature concerning the rational expectations hypothesis. A futures market trader is assumed to use the set of publicly available information to forecast future spot and futures prices. The price risk associated with a given portfolio is defined as the variance of the return on the portfolio, conditional on the set of publicly available information. A futures market position is termed a hedge of a particular spot position if it minimizes the risk of the portfolio of spot and futures positions; the effectiveness of the hedge is defined as the proportional reduction in the risk of the spot position which is achieved by forming the hedge portfolio. Procedures are outlined for estimating the risk-minimizing futures position and the measure of hedging effectiveness. These methods are then used to evaluate hedges of spot positions in 91-day Treasury bills, 3-month commercial papers, 3-month Eurodollar deposits, and 3-month certificates of deposit using the Treasury bill futures contract. The results indicate that the contract is an extremely effective instrument for hedging price risks in those securities. For each security 20 hedges, with durations varying from 2 to 39 weeks, are examined. Point estimates of hedging effectiveness indicate that in 58 of the 80 cases hedging eliminates at least 75 percent of the price risk associated with the unhedged spot position.;The evidence concerning the Treasury bill futures contract should be viewed as extremely tentative. The times series used in the study provides data on only 16 contracts. Moreover, all of the empirical work in the thesis is based on the assumption that the time series is generated by a covariance stationary stochastic process. A growing body of evidence suggests that the Federal Reserve's decision in October 1979 to shift the focus of short-run guides for open-market operations from the federal funds rate toward reserve aggregates produced a pronounced shift in the stochastic behavior of securities prices.;The concept of a rational expectation is used to formalize the notion that futures prices provide forecasts of future spot prices. The rational expectations hypothesis is defined as the hypothesis that a futures price is the objective mathematical expectation of the spot price of the deliverable good on the contract delivery date, conditioned on the set of publicly available information. The validity of this hypothesis as an interpretation of 91-day Treasury bill futures prices is examined using time series data for the period from January 1976 to December 1979. The hypothesis is not rejected.