154 The small size of general bias indicated by a proper interpretation of the statistics raises an interesting theoretical question: Is the effective risk premium really so small; or is there actually a positive bias in expectations proper (the E of the equation Em=E-r) which partially offsets the effects of risk premium? A good argument can be made for either interpretation. On the one hand, it is clear that speculators tend to be people who are not particularly averse to taking risks; many of them, like many people who enjoy gambling may willingly accept even positive risk premiums On the other hand prevalence of the mistaken impression that futures prices tend to be strongly depressed in the period shortly after harvest undoubtedly produces a real positive bias in the price expectations of many indi- idual speculators. Their bias could form the basis for a small positive bias in the consensus of expectations, E In any case, it is clear that any errors in market expectations which arise from general bias must be exceedingly small in comparison with errors from other sources 2. We now turn to the sorts of bias which may result in large errors of market expectation. One of these may be called"conservative bias, "and defined as a tendency for market expectations to delay in adjusting fully to new substantive information. when I was studying potato prices a good many years ago, i thought that I perceived such a bias, involving a tendency for prices to be too low early in the season following a short harvest and too high in the early part of a season following a large harvest, these errors being corrected more or less gradually as the season progressed. Those observations were based, of course, on spot prices of a commodity in which there was then no futures trading So far as i know there has been no demonstration that such a tendency to conservative bias exists in prices of any commodity which has a prominent futures market, with one rather obscure exception That exception is in wheat and is associated with what i called long cycle. 8 Market expectations in wheat seem to have tended tendency is chiefly noteworthy as a of mistaken conclusions; it permits a combina on of data for different futures in such a way as to give a much exaggerated applying the term ycles in Wheat Prices, "Wheat Studies, November, 1931 People with a good deal of mathematical of cycles, I think. Economists have commonly used the term in the broad sense in which n following a disturbance tick by the monheratically mindes s fluctuations swill not terre because it is too broad, content down ed stroe 2 2S R e os wecoldsep2
154 AMERICAN ECONOMIC ASSOCIATION The small size of general bias indicated by a proper interpretation of the statistics raises an interesting theoretical question: Is the effective risk premium really so small; or is there actually a positive bias in expectations proper (the E of the equation Em -E - r) which partially offsets the effects of risk premium? A good argument can be made for either interpretation. On the one hand, it is clear that speculators tend to be people who are not particularly averse to taking risks; many of them, like many people who enjoy gambling, may willingly accept even piositive risk premiums. On the other hand, prevalence of the mistaken impression that futures prices tend to be strongly depressed in the period shortly after harvest undoubtedly produces a real positive bias in the price expectations of many individual speculators. Their bias could form the basis for a small positive bias in the consensus of expectations, E. In any case, it is clear that any errors in market expectations which arise from general bias must be exceedingly small in comparison with errors from other sources. 2. We now turn to the sorts of bias which may result in large errors of market expectation. One of these may be called "conservative bias," and defined as a tendency for market expectations to delay in adjusting fully to new substantive information. When I was studying potato prices a good many years ago, I thought that I perceived such a bias, involving a tendency for prices to be too low early in the season following a short harvest and too high in the early part of a season following a large harvest, these errors being corrected more or less gradually as the season progressed. Those observations were based, of course, on spot prices of a commodity in which there was then no futures trading. So far as I know, there has been no demonstration that such a tendency to conservative bias exists in prices of any commodity which has a prominent futures market, with one rather obscure exception. That exception is in wheat and is associated with what I called a "long cycle."8 Market expectations in wheat seem to have tended tendency is chiefly noteworthy as a source of mistaken conclusions; it permits a combination of data for different futures in such a way as to give a much exaggerated indication of general bias over a period of a year. 8 In applying the term (in "Cycles in Wheat Prices," Wheat Studies, November, 1931, pp. 1-66), I intended no implication of regularity of repetition, or periodicity. People with a good deal of mathematical training accustomed to associate "cycles" with the perfect regularity of a sine curve, have often misinterpreted economists' discussions of cycles, I think. Economists have commonly used the term in the broad sense in which it may designate only the effects of a tendency toward oscillation following a disturbance, including oscillation so highly damped that one disturbance produces only a single perceptible "wave." It is hard to find a good alternative term to avoid possible misinterpretation by the mathematically-minded. "Fluctuations" will not serve because it is too broad, lacking the connotation of progress from one phase to another. This content downloaded from 202.115.118.13 on Wed, 11 Sep 2013 03:21:32 AM All use subject to JSTOR Terms and Conditions
HEORY AND MEASUREMENT OF PRICE EXPECTATIONS 155 usually to respond very tardily to emergence of a large world wheat surplus, and sometimes also to respond tardily to shortage of supplies when low stocks at the beginning of a crop year have aggravated the seriousness of a poor crop On this interpretation, the "long cycle in wheat prices is, or was a reflection of conservatism in response to the stocks position. Possibly heat market expectations will behave differently in the future, with the benefit of better information on actual wheat stocks. If so . the phenomena of the long cycle cannot continue to be taken as evidence f true conservatism of market expectations. They will have to be egarded as effects of bias related to inadequacy of information, to which we now turn 3. Bias in market expectations arising from inadequacy of informa tion is probably the main source of reliable profits for speculators. Many traders in futures markets give a great part of their attention to acquiring information which has not become generally available and thus has not been reflected in market expectations. These traders, or the commission houses which serve them, gather crop information ahead of its reporting by public agencies; they study the weather eports and seek to predict effects of the weather on the crops, thus trying actually to base expectations on crop developments which have not yet occurred; and they have even employed a long-range weather forecaster to predict the weather several weeks ahead The tendency in futures markets, therefore, is for most classes of pertinent information to be brought to bear on market expectations ith extraordinary promptness. Errors arising from failure to obtain or to use available information of known pertinence are small and very short-lived. There are, nevertheless, certain recognizable tend encies toward bias arising from failure to give due attention to available information. The bias associated with level of wheat stocks entioned above, may be an example. a clearer example again from the wheat market, appears in the tendency for market expectations in the United States to give too little attenion to much news from overseas Critical studies of price behavior in other futures markets are needed before confident interpretation can be the tendency of American wheat markets to ignore pertinent fe ews. Possibly there is a general tendency for any market to ignore events that are distant; but this conclusion should not be drawn too hastily on superficial evidence. There is much evidence to the contrary. It may Perhaps the best evidence on this point is in Robert D, Calkins, "Price Leadership mong Major Wheat Futures Markets, " Wheat Studies November, 1933 pp.35-70 content down ed stroe 2 2S R e os wecoldsep2
THEORY AND MEASUREMENT OF PRICE EXPECTATIONS 155 usually to respond very tardily to emergence of a large world wheat surplus, and sometimes also to respond tardily to shortage of supplies when low stocks at the beginning of a crop year have aggravated the seriousness of a poor crop. On this interpretation, the "long cycle" in wheat prices is, or was, a reflection of conservatism in response to the stocks position. Possibly wheat market expectations will behave differently in the future, with the benefit of better information on actual wheat stocks. If so, the phenomena of the long cycle cannot continue to be taken as evidence of true conservatism of market expectations. They will have to be regarded as effects of bias related to inadequacy of information, to which we now turn. 3. Bias in market expectations arising from inadequacy of information is probably the main source of reliable profits for speculators. Many traders in futures markets give a great part of their attention to acquiring information which has not become generally available, and thus has not been reflected in market expectations. These traders, or the commission houses which serve them, gather crop information ahead of its reporting by public agencies; they study the weather reports and seek to predict effects of the weather on the crops, thus trying actually to base expectations on crop developments which have not yet occurred; and they have even employed a long-range weather forecaster to predict the weather several weeks ahead. The tendency in futures markets, therefore, is for most classes of pertinent information to be brought to bear on market expectations with extraordinary promptness. Errors arising from failure to obtain or to use available information of known pertinence are small and very short-lived. There are, nevertheless, certain recognizable tendencies toward bias arising from failure to give due attention to available information. The bias associated with level of wheat stocks, mentioned above, may be an example. A clearer example, again from the wheat market, appears in the tendency for market expectations in the United States to give too little attenion to much news from overseas.9 Critical studies of price behavior in other futures markets are needed before confident interpretation can be given the tendency of American wheat markets to ignore pertinent foreign news. Possibly there is a general tendency for any market to ignore events that are distant; but this conclusion should not be drawn too hastily on superficial evidence. There is much evidence to the contrary. It may 9Perhaps the best evidence on this point is in Robert D. Calkins, "Price Leadership and Interaction among Major Wheat Futures Markets," Wheat Studies, November, 1933, pp. 35-70. This content downloaded from 202.115.118.13 on Wed, 11 Sep 2013 03:21:32 AM All use subject to JSTOR Terms and Conditions