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The Conditional Price of Basis Risk: An Investigation Using Foreign Exchange Instruments

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  • Joëlle Miffre

Abstract

This paper uses a conditional multifactor model and shows that the basis of foreign currency instruments includes a time‐varying risk premium that is related to the conditional risk of the basis and to the conditional prices of systematic risk present in all assets markets. The result therefore reinforces the view, initially put forward by Bailey and Chan (1993), that the basis is priced rationally in an efficient market. The article also shows that the premium for basis risk increases with the maturity of the instruments used for hedging.

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  • Joëlle Miffre, 2004. "The Conditional Price of Basis Risk: An Investigation Using Foreign Exchange Instruments," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 31(7‐8), pages 1043-1068, September.
    • Handle: RePEc:bla:jbfnac:v:31:y:2004:i:7-8:p:1043-1068
    DOI: 10.1111/j.0306-686X.2004.00566.x
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    References listed on IDEAS

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    1. Eugene F. Fama & Kenneth R. French, 2015. "Commodity Futures Prices: Some Evidence on Forecast Power, Premiums, and the Theory of Storage," World Scientific Book Chapters, in: Anastasios G Malliaris & William T Ziemba (ed.), THE WORLD SCIENTIFIC HANDBOOK OF FUTURES MARKETS, chapter 4, pages 79-102, World Scientific Publishing Co. Pte. Ltd..
    2. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-1054, July.
    3. Michael C. Jensen, 1968. "The Performance Of Mutual Funds In The Period 1945–1964," Journal of Finance, American Finance Association, vol. 23(2), pages 389-416, May.
    4. Bailey, Warren & Chang, K C, 1993. "Macroeconomic Influences and the Variability of the Commodity Futures Basis," Journal of Finance, American Finance Association, vol. 48(2), pages 555-573, June.
    5. Bessembinder, Hendrik & Chan, Kalok, 1992. "Time-varying risk premia and forecastable returns in futures markets," Journal of Financial Economics, Elsevier, vol. 32(2), pages 169-193, October.
    6. Harvey, Campbell R, 1995. "Predictable Risk and Returns in Emerging Markets," The Review of Financial Studies, Society for Financial Studies, vol. 8(3), pages 773-816.
    7. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
    8. Chan, Louis K. C. & Karceski, Jason & Lakonishok, Josef, 1998. "The Risk and Return from Factors," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 33(2), pages 159-188, June.
    9. McCurdy, Thomas H & Morgan, Ieuan, 1992. "Evidence of Risk Premiums in Foreign Currency Futures Markets," The Review of Financial Studies, Society for Financial Studies, vol. 5(1), pages 65-83.
    10. Joëlle Miffre, 2000. "Normal backwardation is normal," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 20(9), pages 803-821, October.
    11. Mark G. Castelino & Jack Clark Francis, 1982. "Basis speculation in commodity futures: The maturity effect," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 2(2), pages 195-206, June.
    12. Ferson, Wayne E & Harvey, Campbell R, 1993. "The Risk and Predictability of International Equity Returns," The Review of Financial Studies, Society for Financial Studies, vol. 6(3), pages 527-566.
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    1. Patrick L. Brockett & Mulong Wang & Chuanhou Yang, 2005. "Weather Derivatives and Weather Risk Management," Risk Management and Insurance Review, American Risk and Insurance Association, vol. 8(1), pages 127-140, March.

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