Monday, May 12, 2008

Financial anti-matter

The recent paper "Is Managed Futures an Asset Class? The Search for the Beta of Commodity Futures" approaches this extraordinarily timely question from an unusual angle: practice. The fashionable economics ingredients promise to make it no less appealing: behavioural finance, disequilibrium and reflexivity theory. The authors question some of the most basic assumptions of the commodities futures markets and propose a hedging response model that distinguishes between four different market scenarios which may result in markedly different systematic roll returns. While the predictive value of this model is not immediately obvious, its ex post explanatory power is quite impressive. Most surprisingly, it is a good read, too. Here is their answer to the question: 
Answering our own question is managed futures is an asset class? It is anything, but ... If anything, it is the "anti-asset class". It is an observable materialization of behavioral finance, where risk, return, leverage and skill operate un-tethered from the anchor of an accurate representation of beta. In other words, it defies rational expectations equilibrium, the efficient market hypothesis and allied models—the CAPM, arbitrage pricing theory or otherwise—to single-handedly isolate a persistent source of return without that source eventually slipping away. (...) Unbeknownst to modern finance, the commodity futures markets may be the shoals against which rational expectations equilibrium, the "de facto ruling paradigm of financial economics," is eventually shipwrecked.

In view of this and particularly this, it may perhaps be time to indeed revisit one's CF long exposure, which has been entered into on the possibly naive assumption that the futures markets are tightly monitored net zero sum games that have no impact on the spot markets. 

No comments: