Testing Backwardation and Contango Effects on a 3 – Month Eurodollar Futures Contract

In this article, we test the backwardation and contango effects on a 3 – month Eurodollar futures contract by applying a vector error correction, VEC, model. Backwardation is a case where the futures price is below the spot price. It takes place when there is advantage to hold the underlying asset that offset the opportunity cost of the risk-free rate and additional net holding costs. In contrast, contango is a case where the futures price is above the spot price. In a speculation situation, the futures prices do not equal spot prices and speculators are taking advantage from the mispricing. Speculators are short or long according to if the futures market is in backwardation or in a contango situation. In case, that the investor is not getting dividends, semi-annual coupons or monthly yields and the futures price are greater then the spot prices, then, we are discussing about a contango effect