Investments, tenth edition

   Expectations Hypothesis 

 The   expectations hypothesis  is the simplest theory of futures pricing. It states that the 

futures price equals the expected value of the future spot price:  F  

0

      5     E ( P  

 T 

 ). Under this 

theory the expected profit to either position of a futures contract would equal zero: The 

short position’s expected profit is  F  

0

      2     E ( P  

 T 

 ), whereas the long’s is  E ( P  

 T 

 )   2     F  

0

 .  With 

 F  

0

   5   E ( P  

 T 

 ), the expected profit to either side is zero. This hypothesis relies on a notion 

of risk neutrality. If all market participants are risk neutral, they should agree on a futures 

price that provides an expected profit of zero to all parties. 

 The expectations hypothesis resembles market equilibrium in a world with no uncertainty; 

that is, if prices of goods at all future dates were currently known, then the futures price for 

delivery at any particular date would equal the currently known future spot price for that date. 

It is a tempting but incorrect leap to then assert that under uncertainty the futures price should 

equal the currently  expected  spot price. This view ignores the risk premiums that must be 

built into futures prices when ultimate spot prices are uncertain.  

    22.5 

Futures Prices versus Expected Spot Prices 

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7/27/13   1:48 AM

7/27/13   1:48 AM

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  Options, Futures, and Other Derivatives