The Insurance Theory was found to be lacking based on two empirical findings. The
first finding is that for markets in backwardation, buying futures has not resulted in
the extra returns the theory says buyers should receive for providing “insurance.
The second finding is that many markets are not in backwardation but are in
contango (future prices higher than spot prices), which would imply a negative
return for providing insurance to producers.
Please explain the above findings.
The findings are actually self-explanatory.
According to the insurance theory, producers hedge by selling futures and speculators provide insurance by buying those futures sold……it was found that even in backwardation, such futures bought by speculators weren’t sufficiently low priced to provide them with a higher expected return. So, they refused to provide insurance.
Secondly, at times the commodity market was in contango, which would once again make the same unattractive for speculators to buy futures in anticipation of a negative roll yield.