The Theoretical Source of Autocorrelation in Forward and Futures Price Relationships Michael A. Polakoff Fernando Diz zyxw INTRODUCTION hen investigated, evidence of autocorrelation consistently is revealed by em- pirical analyses of comparable forward and futures contracts.' For example, Vignola and Dale (1979) and Rendleman and Carabini (1979) find that time series of Treasury-bill forward and futures price differences are autocorrelated. In this re- gard, they note the systematic patterns of sign reversals that occur when sequences of delivery-matched Treasury-bill forward and futures rates are subtracted for the purpose of examining a mean rate differential. French (1983) confirms that such patterns arise as well for copper and silver forward-futures time series. In doc- umenting that resettlement causes systemic pricing differences between currency for- ward and futures contracts, Polakoff and Grier (1991) note the same find- ing. Rubinstein (1987) concludes that the autocorrelation phenomenon is shown to be prevalent in studies contrasting forward values of the S&P 500 index against cor- responding index futures prices. In his view, no satisfactory explanation yet has been offered that accounts for this relationship. The absence of insight into the autocor- relation property is not surprising, inasmuch as theory posits that forward cash flows can be replicated with futures contracts in a manner that will result in irrele- vant and nonsystemic differences between the instruments' prices (Levy, 'To be considered strictly comparable, forward and futures contracts must not only be written for identical underlying commodity units and quality, but they must also share an identical term to deliv- ery [Chang and Chang (1990)l. The term-to-delivery constraint tends to limit the use of reported price data for commodities where forward contracts exist zyxwv on a nonsynthetic basis. For this reason, (nonsynthetic) currency forward and futures prices cannot be contrasted on a daily basis [Chang and Chang (1990)l. Thus, while a number of studies examine the time series properties of daily currency forward and futures rates, [e.g., Hall, Brorsen, and Irwin (1989); So (1987); Hodrick and Srivastava (1987, 1984); Westerfield (1977)], such analyses cannot be used to make direct inferences about forward-futures price relationships. In markets where forward contracts are structured on an implied basis (such as Treasury-bills or the S&P 500 index), delivery matching poses far fewer difficulties. zyxwv Michael A. Polabff zyxwvuts is an Assistant Professor of Finance at Syracuse University. Fernando zyxwvut Diz is an Assistant Professor of Finance at Syracuse University. The Journal of Futures Markets, Vol. 12, No. zyxwvu 4, 459-473 (1992) zyxwv 0 1992 by John Wiley zyxwvuts & Sons, Inc. CCC 0270-7314/92/040459-15$04.00