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Nonlinear Mean Reversion and Arbitrage in the Gold Futures Market

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  • Jeng-Bau Lin

    ()
    (Department of Business Administration, National Chung-Hsing University)

  • Jin-Ming Liang

    ()
    (Department of Information Management, Hsing Kuo University of Management)

  • Chin-Chia Liang

    ()
    (Department of Business Administration, National Chung-Hsing University)

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    Abstract

    Previous literatures take transaction costs as being negligible when analyzing the futures basis behavior in linear dynamic framework. However, we argue that the relationship between the futures and spot prices with the conventional linear cointegration approach may not be appropriate after taking transaction costs into account. In this paper, an incorporation of transaction costs presented by Dumas (1992) and Michael (1997) into the exponential smooth transition autoregressive (ESTAR) model developed by Granger and Terasvita (1993) is motivated to examine the dynamic relationship between daily gold futures and spot prices and the nonlinear behavior of the gold futures basis. Transaction costs may lead to the existence of neutral band for futures market speculation within which profitable trading opportunities are impossible. Further, our results indicate that the ESTAR model provides higher forecasting power than the linear AR(1) model.

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    File URL: http://www.accessecon.com/pubs/EB/2008/Volume6/EB-07F30020A.pdf
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    Bibliographic Info

    Article provided by AccessEcon in its journal Economics Bulletin.

    Volume (Year): 6 (2008)
    Issue (Month): 9 ()
    Pages: 1-11

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    Handle: RePEc:ebl:ecbull:eb-07f30020

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    1. Dumas, Bernard, 1992. "Dynamic Equilibrium and the Real Exchange Rate in a Spatially Separated World," Review of Financial Studies, Society for Financial Studies, vol. 5(2), pages 153-80.
    2. Michael, Panos & Nobay, A Robert & Peel, David A, 1997. "Transactions Costs and Nonlinear Adjustment in Real Exchange Rates: An Empirical Investigation," Journal of Political Economy, University of Chicago Press, vol. 105(4), pages 862-79, August.
    3. Chen, Show-Lin & Wu, Jyh-Lin, 2000. "A Re-Examination of Purchasing Power Parity in Japan and Taiwan," Journal of Macroeconomics, Elsevier, vol. 22(2), pages 271-284, April.
    4. Terasvirta, T & Anderson, H M, 1992. "Characterizing Nonlinearities in Business Cycles Using Smooth Transition Autoregressive Models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 7(S), pages S119-36, Suppl. De.
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