Question

"The normal backwardation hypothesis assumes that market participants are risk-neutral; that is, they do not require a risk premium in taking a risky position." True or false?

Answer 1

Based on this theory, the futures price at the present time is equal to the expected spot price; that is, F0=E(ST). Remember that at time T, the realized net income to the long position per unit of the underlying asset is ST– F0and to the short position F0– ST. Therefore, the expected net income at time 0 is E(ST)– F0to the long and F0– E(ST) to the short. If F0=E(ST) according to this theory, E(ST)– F0= F0– E(ST) =0; that is, the expected profits to either side is zero. Apparently, this theory assumes that market participants are risk-neutral; that is, they do not require a risk premium in taking a risky position.

Answer : True