OPTIMAL SPREADING WHEN SPREADING IS OPTIMAL

This paper assumes an investor who has a non-traded position operating in a stochastic interest rates environment. The investor trades conti nuously either distinct futures contracts or distinct forward contract s in order to maximize his expected utility of terminal wealth. In ord er to reach the welfare level of the first best optimum, the investor must incorporate into his portfolio either two distinct futures contra cts or two distinct forward contracts. The optimal forward contracts d ynamic spreading strategy has two components, a speculative component and a minimum-variance hedging component. The minimum-variance hedging component is composed of a short position in the nearby contract and a long position in the deferred contract. The speculative component se rves to replicate the growth optimum portfolio. The speculative compon ent is composed of a short position in the contract which is the most negatively correlated with the growth optimum portfolio and a long pos ition in the other contract. The marking-to-market procedure of the fu tures positions forces the investor to hold less futures contracts tha n the corresponding forward contract positions. The analysis is also e xtended to incomplete markets and to inter-market spreading. (C) 1998 Elsevier Science B.V. All rights reserved.