An empirical note on demand for speculation and futures risk premium: A Kalman Filter application

This study examines the behavior of demand for speculation, and the relationship between futures risk premium, open interest, daily futures trading, and the market index in the case of gold, silver, and copper markets. Following Bessembinder (1992), the paper focuses on the questions of: (a) whether there is a consistent systematic relationship between risk premium and futures trading activity and the market index, and, (b) whether speculative behavior exhibits systematic behavior around the market's expectation. The introduction of the Kalman Filter approach allows for a flexible trend model and obviates the need to specify the nature of trends of series. In order to test the hypotheses the frequency-domain regression coefficients are compared with their case- specific counterparts. The empirical findings show that the speculative behavior is not symmetric in backwardation and contango markets. Furthermore, a negative relationship between the market and risk premia is observed in gold and silver; whereas the same relationship is positive in the case of copper. © 1997 JAI Press Inc.