OFOR Symposium: October, 1994

Futures Markets in the 21st Century


Futures markets have undergone tremendous changes during the past three decades. After futures contracts for nonstorable commodities were successfully introduced in the 1960's, innovative and successful contracts for currencies, interest rate instruments, stock indices, the energy complex, and others were introduced. These expansions and industry growth brought an increase in futures trading volume in the United States of more than 16% per annum (approximately 19-fold) since 1970. In addition, of major significance to the futures industry was the introduction ten years ago of options on futures contracts. Concurrently, the industry has transformed and adapted rapidly to the highly technical computer, electronic telecommunication and information revolution.

Even with these successes, leadership and innovation, the futures industry faces many challenges as it moves toward the 21st century. Despite the tremendous growth domestically, trading volume in the U.S. now totals less than 50 percent of world futures trading. Most of the new derivative exchanges being introduced overseas are fully automated with computerized trading. Competition internationally will become intense, especially as trading shifts toward being conducted 24-hours a day and markets become globally linked. Responding to customer needs, exchanges are devising and testing new contracts such as air pollution rights, catastrophic insurance, rolling spots on currencies, crop yield insurance, and others. Regulation will soon address the huge related industry of over-the-counter derivatives such as swaps.

With these challenges in mind, OFOR sponsored a conference "Futures Markets in the 21st Century" held on October 24, 1994 at the Chicago Mercantile Exchange (CME). The conference was designed to look forward and envision the structure and operation of futures and options markets in the next century. In addition to the three key papers summarized below, a panel discussion was lead by Todd E. Petzel (Executive Vice President, Business Development CME), Steven Manaster (Professor University of Utah) and Jeffrey Silverman (Member, Board of Directors CME).

Professor Elizabeth Tashjian, University of Utah, in a paper "Optimal Futures Contract Design" discussed key features underlying successful futures contracts. These features include a hedging need, underlying cash markets that are large and have volatile prices, futures prices closely correlated with assets held by hedgers, and asymmetric motivations of long and short traders. Modelling contract form must also take into account the delivery provisions and options.

Professor Ian Domowitz, Northwestern University, explored alternative market arrangements for the next century, especially the prospect of electronic exchange, in a paper "Electronic Derivatives Exchanges: Implicit Mergers, Network Externalities and Standardization". He argues that the electronic exchange structure will, through network and liquidity effects, lead to multinational implicit mergers between exchanges. Linkages among exchanges under electronic umbrellas are already being created. However, this structure is not predicted to replace floor trading activities due to a bias against standardization.

Professor Robert J. Shiller, in a paper "Aggregate Income Risks and Hedging Mechanisms" examined the prospects for new contracts devised to hedge aggregate income and revenue streams, such as national income, labor income and real estate. Most risks that households and countries face, aggregate income flows, cannot
be hedged. Therefore, he advocates the creation of markets for perpetual claims, or perpetual futures markets, to allow trading of perpetual income streams.

These papers are creative and innovative in exploring potential features of futures markets as they will exist into the 21st century. Interested students of futures markets should read them. Full versions of the papers may be found in the Spring 1995 issue of the Quarterly Review of Economics and Finance. Subscription and individual issue inquiries can be addressed to Editor, QREF, Bureau of Economics and Business Research, 420 Commerce West, 1206 South 6th Street, Champaign, IL 61820.