CFA completely messed up contango/backwardation!

Hi all, it is my knowledge, that when futures prices are higher than spot prices, futures curve is upward sloping (although CFA calls this contango). When other way round, is downward sloping. (CFA calls this backwardation)

However, backwardation is when futures prices are higher than expected spot prices. This is in-line with insurance theory - long-futures require a premium over expected future spot.

When this premium is negative, i.e., I am willing to pay more than I expect the spot price be in the future, market is in contango (this happens sometimes on gold market).

I know people get this generally wrong, but I wouldn’t expect this from CFA!!

What to do with this?

Thanks, JZ

My understanding – granting that I have never dealt with futures markets professionally, so my knowledge is purely academic – is that what you’re describing is not backwardation but normal backwardation. In backwardation, futures prices are below spot prices, but in normal backwardation, futures prices are below expected spot prices. This appears to be in line with the language in Keynes’ 1930 A Treatise on Money.

I’ll leave the research to you.

Historically, the CFA curriculum has distinguished backwardation from normal backwardation, and contango from normal contango.



This answer would be absolutely fantastic, unfortunately it is not the case. In current CFA II curriculum, there is written about insurance theory that

“this theory posits that the futures price has to be lower than the current spot price as a form of payment or remuneration to the speculator who takes on the price risk and provides price insurance to the commodity seller.”

They also say, that because of this “normal” behaviour, they call it “normal backwardation”

I’m telling you, they completely messed up :smiley:

More citing from the book…

"Keynes’ theory assumes that the futures curve is in backwardation “normally”
because our farmer would persistently sell forward, pushing down prices in the future"

I haven’t a copy of the current Level II curriculum. When I said, “historically”, I meant in many years past.

You’re correct, that passage describes backwardation, not normal backwardation.

I encourage you to submit an erratum request to CFA Institute, here. Historically (there’s that word again!), CFA Institute has generally been quite responsive to my erratum suggestions (though sometimes they have decided, erroneously, that I was wrong).

Best of luck!

Bill, JZ let me know what CFAI has to say.