RDP 2004-07: The Profitability of Speculators in Currency Futures Markets 2. Description of the Data

Our analysis uses seven major currencies for which futures contracts have traded on the Chicago Mercantile Exchange (CME): the Australian dollar (AUD), British pound (GBP), Canadian dollar (CAD), the euro (EUR), the German mark (DEM), Swiss franc (CHF) and Japanese yen (JPY). Our futures prices and open interest by contract are from the Institute for Financial Markets which collects the data from the CME. Since the prices of the futures contracts we use are quoted in US dollars, we will refer to the other currencies collectively as the ‘foreign’ currencies.

For each currency there is a contract that expires every third month; in March, June, September and December. Contracts typically start trading around 12 months before expiration, though they don't become highly liquid until just before the previous contract expires and so are highly liquid for just over 3 months. Over 90 per cent of open interest is typically in the next to expire contract. The weekly returns on various expiration date contracts for a given currency move almost identically (the correlations are over 0.99). This is because most movement in currency futures prices come from changes in the spot exchange rate which is the base for all futures prices.

Data on the positions held by speculators and hedgers in currency futures contracts are obtained from the Commodity Futures Trading Commission (CFTC). These data are published at a weekly frequency from 1993. The data are measured at close of business Tuesday, and so references in this paper to a week will refer to the week ending Tuesday. The CFTC aggregates individual trader positions into long and short positions of speculators (non-commercial traders) and hedgers (commercial traders). For each currency, the positions of each trader type are aggregated over contracts with different expiration dates. For example, the CFTC reports the total of the long positions held by speculators in the various Australian dollar futures contracts trading at the end of each week.

The CFTC data only report the total positions of large speculators and hedgers. These large traders account for about 70 per cent of the total value of positions in the currency markets considered here.^[1] Speculators account for about 20 per cent of the total value of positions and hedgers account for approximately half.

Speculators are traders who do not have a foreign exchange exposure they want to hedge and so their only reason for trading is to make profits. Their demand for a currency future should therefore depend on their expectation of the price change, and perception of the risk in holding the futures contract.^[2] Hedgers are traders who have fundamental exposure to the exchange rate in the form of future payments or receipts of that foreign currency, for example future revenue from exports or investment income.^[3] Hedgers' demand for a currency future would then be a function of their foreign currency flows as well as their expectations and perceptions of the risk. The net position in the currency future of these groups is defined as:

where j is either speculators (S) or hedgers (H), t is time, and long and short are the number of long contracts and short contracts held in the foreign currency by trader type j.

These data do not allow us to examine the heterogeneity of positions within the two groups, speculators and hedgers. However the heterogeneity across these groups is far greater than within. When speculators have a particular net position, either long or short, on average 80 per cent of their total contracts are in this direction, while just 30 per cent of hedgers' contracts are in this direction. The relative behaviour of the two classes of investors is therefore of interest because they clearly have different incentives to trade.

Every futures contract has both a buyer (who is long) and a seller (who is short), so the net positions of all traders must sum to zero. The CFTC uses this condition and the reported information on speculator and hedger positions to back out the positions of small traders. We find that the net position of small traders is very highly correlated with that of speculators.^[4] In this paper we focus on speculators as this is the most homogenous of the trader groups; it is particularly unclear what the trading motives are for small traders. The results for hedger positions are qualitatively similar to those for speculators but with the opposite sign.

Descriptive statistics for the net position of speculators in currency futures for each of the six currencies are reported in Table 1. The first column is the size of a futures contract in each currency. While comparisons obviously depend on exchange rates, these contracts are broadly similar in value. Over the period speculators were, on average, long in the Australian dollar and the euro and short in the other five currencies.

Figures 1 to 4 show the weekly speculator net position and futures price data for the six currencies (with the mark and euro combined). These figures show that speculators' positions demonstrate some persistence with clear bunching of positions of similar magnitude. However, as shown in the Appendix A, standard time-series tests strongly suggest that they are stationary. The observed persistence does not preclude large, rapid changes in positions. Table 1 shows that the absolute changes in net positions are large, at least relative to the mean absolute position.

Like exchange rates, futures prices are volatile, with average weekly returns of around 1 per cent. The stationarity tests reported in the Appendix A demonstrate that the common finding that exchange rates are non-stationary carries over to currency futures prices. We therefore use the first difference of the logged futures price (multiplied by 100) in our analysis.

For all currencies, Figures 1 to 4 suggest that speculators, as a group, appear to have a long foreign currency futures position when the futures price is rising and be short when the price is falling. This suggests that these positions were profitable. For example, Figure 1 shows that speculators were short during the depreciation of the Australian dollar in 1997. Speculators also appear to increase their net long position when the futures price is rising, and conversely decrease these positions when the futures price is falling. This is confirmed by correlations of the change in net speculator position and the change in the futures price for different currencies of between 0.45 and 0.62, which are all significant at the 1 per cent level. We now move on to attempt to quantify these profits.

Footnotes

‘Large’ currently means traders who hold more than 400 contracts in one currency and expiration date. The contract sizes in Table 1 show that these thresholds are 40 million AUD, 25 million GBP, etc. [1]

Speculators' demand might also depend on correlations of futures prices with other asset prices. [2]

There is a large literature on why firms hedge, for example see Johnson (1960) and Pennings and Leuthold (2000). [3]

The correlation of the net position of speculators and small traders for the Australian dollar is 0.88, for the Canadian dollar 0.60, for the pound 0.82, for the yen 0.77 and for the franc 0.82. The total net positions of small traders are also of a similar magnitude to those of speculators. [4]