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Forecast Encompassing as the Necessary Condition to Reject Futures Market Efficiency: Fluid Milk Futures
Author(s) -
Sanders Dwight R.,
Manfredo Mark R.
Publication year - 2005
Publication title -
american journal of agricultural economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.949
H-Index - 111
eISSN - 1467-8276
pISSN - 0002-9092
DOI - 10.1111/j.1467-8276.2005.00751.x
Subject(s) - futures contract , inefficiency , futures market , economics , transaction cost , econometrics , forward market , financial economics , quarter (canadian coin) , microeconomics , archaeology , history
The traditional necessary condition for futures market inefficiency is the existence of alternative forecasting methods that produce mean squared forecast errors smaller than the futures market. Here, a more exacting requirement for futures market efficiency is proposed—forecast encompassing. Using the procedure of Harvey and Newbold, multiple forecast encompassing is tested using Chicago Mercantile Exchange fluid milk futures. Time series models and USDA experts provide competing forecasts. Results suggest milk futures do not encompass the information contained in the USDA forecasts at a two‐quarter horizon. While the competing forecasts generate positive revenues, it is unlikely that returns exceed transaction costs in this relatively new market.