A test of the cost of carry relationship for the Australian 90 day bank accepted bill futures market

A test of the cost of carry relationship for the Australian 90 day bank accepted bill futures market

In competitive markets participants in the markets rapidly drive out arbitrage profits. Thus, assuming markets are competitive, cointegration provides one test of arbitrage based pricing models as this test identifies 'longer-term' deviations from an equilibrium relationship. In this paper the equilibrium is described by the cost of carry model, an arbitrage relationship between the bank accepted bill price, the bank accepted bill futures price and the interest rate to futures contract maturity. Time series observations are available for 90 day bank accepted bill futures contracts starting with the contract maturing in June 1980 extending through to the contract maturing in March 1990. Unit root tests are conducted on the times series and these identify the underlying variables in the cost of carry relationship as I(1) processes. Cointegration tests are then applied to test for longer-term deviations from the cost of carry relationship. The level of cointegration identified in these series increases in the later half of the 1980's. Perhaps the most dramatic change in the money market occurred over the period September 1985 to April 1986 when fourteen new foreign banks set up operations in the Australian market. This resulted in a dramatic increase in the level of competition among the trading banks, the major players in the bank accepted bill futures market. Perhaps the additional players in the market and the dramatic growth in the bill market resulted in greater attention being paid to arbitrage profits arising between the bank accepted bill, and bank accepted bill futures markets.

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