Why Stock Index Futures Do Not Forecast Index Returns
Article Quant Q&A · Author: curious
Summary
The document explains why stock index futures are not generally read as forecasts of how much an equity index will rise, even though interest rate futures are often used to infer rate expectations. Index futures can be used to derive a forward curve and infer implied dividend yields and repo costs, much as interest rate futures help construct a curve for rates.
The answers emphasize that equity index futures are linked to a tradable spot index. Arbitrage ties futures prices to spot prices through financing costs and expected dividends, so the futures price mainly reflects carry rather than independent information about future index levels. Interest rate futures reference distinct future rate periods and lack the same direct spot-and-carry relationship. These are theoretical explanations: futures prices are risk-neutral prices, and whether implied rate expectations forecast realized rates is a separate question. Real markets may also depart from the simplified arbitrage relationship.
Key ideas
- Index futures can imply forward dividend yields and repo costs through their relationship to spot prices.
- Equity index futures prices are largely determined by spot, financing costs, dividends, and arbitrage.
- A futures price linked to a tradable underlying does not by itself provide an independent forecast of the underlying's return.
- Interest rate futures across different periods can convey information that is not mechanically derived from one spot rate.
- Risk-neutral pricing and realized forecasting performance are distinct concepts.
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# Answer by Antoine Conze (score 6, accepted) # Why are stock index futures not used to forecast how much the stock market will rise, given that interest rates futures are used for this purpose? In news articles, the reader often read interest rates forecasts calculated based on interest rate futures. An example is here; How did traders calculate that the expected number of rate hikes is 4 based on eurodollar futures on 15Feb2018? I have never come across anyone forecasting how much the S&P500 will rise for the year based on S&P500 futures. Why not, given that interest rates futures can be used to forecast how much interest rates can rise? What is the difference between interest rates futures and stock index futures that one can be used to make forecast while the other cannot? ## Answer by Antoine Conze (score 6, accepted) https://quant.stackexchange.com/a/38257 Interest rate futures enable you to build an interest rate projection curve which you can think of as representing the risk neutral expectation of rates in the future, therefore providing you with a "forecast" of rates in the future. Likewise, stock index futures enable you to build a dividend yield and repo cost projection curve which you can think of as representing the risk neutral expectation of dividend yield and repo cost in the future. To build such as curve you first compute the stock index forward curve and then divide by the current stock index value. That curve provides you with a "forecast" of dividend yield and repo cost in the future. In essence when you work in the interest rate world the natural numeraire is the currency, whereas when you work in the stock world the natural numeraire is the stock itself, and dividend yield & repo cost for stocks become the equivalent of interest rates for currencies. ## Answer by dm63 (score 6) https://quant.stackexchange.com/a/38258 I would put it slightly differently. For Stock index futures , the 2019 contract has the same underlying stocks as the spot index. Therefore the futures price can be simply calculated as spot price increased by interest rates and decreased by dividends. The futures price does not contain any interesting new information about stocks that you cannot see in the spot index. For interest rate futures , the Fed Funds futures for March 2019 (say) is a completely different underlying than the Fed Funds futures for Feb 2018. One cannot be calculated from the other. Hence there is interesting new information by looking at the interest rate futures. ## Answer by vonjd (score 5) https://quant.stackexchange.com/a/38253 The main reason is that with interest rate futures interest rates are entering the pricing formula because they are not hedged while with stock index futures the indices are being hedged (while interest rates also enter the pricing formula here!) So with index futures you price the index in a risk-neutral way while with interest rate futures (and index futures!) you don't price the interest rates in a risk-neutral way. More on the rationale behind risk-neutral pricing see here: https://quant.stackexchange.com/a/107/12 This might be helpful too: https://quant.stackexchange.com/a/8252/12 ## Answer by Chan-Ho Suh (score 5) https://quant.stackexchange.com/a/38265 People are all kinda dancing around the straighforward answer, which is that you can trade the underlying for a stock index future but not for an interest rate future. When you can trade the underlying, arbitrageurs will push the future and its underlyer prices as close together as possible. The difference is roughly the cost or gain from the arbitrage strategy. Thus the price of the future for a stock index is determined by arbitrage and has no forecasting value (in theory, or at least the theory I'm referencing -- the real world may beg to differ). Since the same consideration is not true for an interest rate future (at least not in such a straightforward way), its price is set by market expectations. Whether or not that has forecasting value is its own question, but hopefully this answers the question of why one future seems to be a reflection of expectations while the other basically just moves with spot.
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