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ECON-252-11: FINANCIAL MARKETS (2011)

Lecture 15 - Forward and Futures Markets [March 21, 2011]

Chapter 1. Forwards vs. Futures Contracts; Speculation in Derivative Markets [00:00:00]

Professor Robert Shiller: OK, good morning. Well, today I want to talk about what, to me, is a very interesting topic, and that is futures markets. Not very interesting to most people. Most people have no idea what they are. But I think that, well, futures markets, what we're really talking about is —

There are different ways of viewing it. Futures markets for things like agricultural commodities, or interest rates, or financial securities, are markets about the future. They're markets that, in some sense, predict the future. And future matters, right? We live a life. We have a long horizon. I said before, I think that your planning horizon must be at least a century, because you'll probably live that long anyway, with modern medicine. And you care about other people, too.

So, the beauty of futures markets is that we have prices for the future. We talked already about forward markets. We talked about forward interest rates. And that is related to what we're talking about. Forwards and futures are similar concepts. Futures is the more precise concept, or the more developed concept. And I'll explain the difference between forwards and futures. But just in a nutshell, futures markets are organized markets, like the stock market, that trade standardized contracts, representing things that will happen at future dates. And because they're standardized, they're worldwide. Everybody looks at them and uses them. Whereas forward markets are more specialized markets that, typically, are not as easy to interpret or as clear.

So, futures markets are, in some sense, more fundamental and important. I have a particular interest — I've been interested in futures markets myself for many years. And wondering, why they're not even bigger and more important. So, in 1993, I wrote a book called Macro Markets, about let's make our markets bigger and more important, and more pervasive. And I've been trying to do that.

Notably, in 2006, I was working with the Chicago Mercantile Exchange, which is the biggest futures market in the world. And we created home price futures. And they've been trading now for five years. But I'm not really going to talk about them, because they have so far disappointed. They're not important, at least not yet. But I'm going to talk about some important futures markets.

First, I want to put just a couple of definitions up. Futures, that's what we're going to talk about most in this lecture, and it has a special meaning in finance. And I was contrasting that to forwards. But both of these together are derivatives. And that means that the price in these markets derives from a price in some other market. There's a primary or underlying market, which has its own price. And then there's a derivative market that has a futures price or a forward price.

I guess I'm speaking in kind of abstract terms. Well, let me just start — I want to give you an example, and we'll see better what I'm talking about.

But let me just first comment just on this word, derivatives. To people in finance, derivatives are an exciting development of financial markets. We start out with a simple market and we develop derivative markets, that add more detail and information than was in the underlying or primary market. That's exciting. I find it exciting.

Lecture 15 - Forward and Futures Markets [March 21, 2011]

Chapter 1. Forwards vs. Futures Contracts; Speculation in Derivative Markets [00:00:00]

Professor Robert Shiller: OK, good morning. Well, today I want to talk about what, to me, is a very interesting topic, and that is futures markets. Not very interesting to most people. Most people have no idea what they are. But I think that, well, futures markets, what we're really talking about is —

There are different ways of viewing it. Futures markets for things like agricultural commodities, or interest rates, or financial securities, are markets about the future. They're markets that, in some sense, predict the future. And future matters, right? We live a life. We have a long horizon. I said before, I think that your planning horizon must be at least a century, because you'll probably live that long anyway, with modern medicine. And you care about other people, too.

So, the beauty of futures markets is that we have prices for the future. We talked already about forward markets. We talked about forward interest rates. And that is related to what we're talking about. Forwards and futures are similar concepts. Futures is the more precise concept, or the more developed concept. And I'll explain the difference between forwards and futures. But just in a nutshell, futures markets are organized markets, like the stock market, that trade standardized contracts, representing things that will happen at future dates. And because they're standardized, they're worldwide. Everybody looks at them and uses them. Whereas forward markets are more specialized markets that, typically, are not as easy to interpret or as clear.

So, futures markets are, in some sense, more fundamental and important. I have a particular interest — I've been interested in futures markets myself for many years. And wondering, why they're not even bigger and more important. So, in 1993, I wrote a book called Macro Markets, about let's make our markets bigger and more important, and more pervasive. And I've been trying to do that.

Notably, in 2006, I was working with the Chicago Mercantile Exchange, which is the biggest futures market in the world. And we created home price futures. And they've been trading now for five years. But I'm not really going to talk about them, because they have so far disappointed. They're not important, at least not yet. But I'm going to talk about some important futures markets.

First, I want to put just a couple of definitions up. Futures, that's what we're going to talk about most in this lecture, and it has a special meaning in finance. And I was contrasting that to forwards. But both of these together are derivatives. And that means that the price in these markets derives from a price in some other market. There's a primary or underlying market, which has its own price. And then there's a derivative market that has a futures price or a forward price.

I guess I'm speaking in kind of abstract terms. Well, let me just start — I want to give you an example, and we'll see better what I'm talking about.

But let me just first comment just on this word, derivatives. To people in finance, derivatives are an exciting development of financial markets. We start out with a simple market and we develop derivative markets, that add more detail and information than was in the underlying or primary market. That's exciting. I find it exciting.

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