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Cointegration and detectable linear and nonlinear causality: analysis using the London Metal Exchange lead contract

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Author Info
An-Sing Chen
James Wuh Lin
Abstract

This study applies linear and nonlinear Granger causality tests to examine the dynamic relation between London Metal Exchange (LME) cash prices and three possible predictors. The analysis uses matched quarterly inventory, UK Treasury bill interest rates, futures prices and cash prices for the commodity lead traded on the LME. The effects of cointegration on both linear and nonlinear Granger causality tests is also examined. When cointegration is not modelled, evidence is found of both linear and nonlinear causality between cash prices and analysed predictor variables. However, after controlling for cointegration, evidence of significant nonlinear causality is no longer found. These results contribute to the empirical literature on commodity price forecasting by highlighting the relationship between cointegration and detectable linear and nonlinear causality. The importance of interest rate and inventory as well as futures price in forecasting cash prices is also illustrated. Failure to detect significant nonlinearity after controlling for cointegration may also go some way to explaining the reason for the disappointing forecasting performances of many nonlinear models in the general finance literature. It may be that the variables are correct, but the functional form is overly complex and a standard VAR or VECM may often apply.

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Article provided by Taylor and Francis Journals in its journal Applied Economics.

Volume (Year): 36 (2004)
Issue (Month): 11 (June)
Pages: 1157-1167
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Handle: RePEc:taf:applec:v:36:y:2004:i:11:p:1157-1167

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

  1. MacDonald, Ronald & Taylor, Mark P, 1988. "Metals Prices, Efficiency and Cointegration: Some Evidence from the London Metal Exchange," Bulletin of Economic Research, Blackwell Publishing, vol. 40(3), pages 235-39, June.
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  3. Bessembinder, Hendrik, et al, 1995. " Mean Reversion in Equilibrium Asset Prices: Evidence from the Futures Term Structure," Journal of Finance, American Finance Association, vol. 50(1), pages 361-75, March. [Downloadable!] (restricted)
  4. Engle, Robert F & Granger, Clive W J, 1987. "Co-integration and Error Correction: Representation, Estimation, and Testing," Econometrica, Econometric Society, vol. 55(2), pages 251-76, March. [Downloadable!] (restricted)
  5. Sephton, Peter S & Cochrane, Donald K, 1991. "The Efficiency of the London Metal Exchange: Another Look at the Evidence," Applied Economics, Taylor and Francis Journals, vol. 23(4A), pages 669-74, Part A, A.
  6. Sephton, Peter S. & Cochrane, Donald K., 1990. "A note on the efficiency of the London metal exchange," Economics Letters, Elsevier, vol. 33(4), pages 341-345, August. [Downloadable!] (restricted)
  7. MacDonald, Ronald & Murphy, P D, 1989. "Testing for the Long Run Relationship between Nominal Interest Rates and Inflation Using Cointegration Techniques," Applied Economics, Taylor and Francis Journals, vol. 21(4), pages 439-47, April.
  8. Milonas, Nikolaos T & Thomadakis, Stavros B, 1997. "Convenience Yield and the Option to Liquidate for Commodities with a Crop Cycle," European Review of Agricultural Economics, Oxford University Press for the Foundation for the European Review of Agricultural Economics, vol. 24(2), pages 267-83.
  9. Scheinkman, Jose A & LeBaron, Blake, 1989. "Nonlinear Dynamics and Stock Returns," Journal of Business, University of Chicago Press, vol. 62(3), pages 311-37, July. [Downloadable!] (restricted)
  10. MacDonald, Ronald & Taylor, Mark P, 1989. "Rational Expectations, Risk and Efficiency in the London Metal Exchange: An Empirical Analysis," Applied Economics, Taylor and Francis Journals, vol. 21(2), pages 143-53, February.
  11. Franses, P.H. & Kofman, P., 1991. "An Empirical Test For Parities Between Metal Prices At The Ime," Papers 9102, Erasmus University of Rotterdam - Institute for Economic Research.
  12. Hall, Anthony D & Anderson, Heather M & Granger, Clive W J, 1992. "A Cointegration Analysis of Treasury Bill Yields," The Review of Economics and Statistics, MIT Press, vol. 74(1), pages 116-26, February. [Downloadable!] (restricted)
  13. MacDonald, Ronald & Taylor, Mark P, 1988. "Testing Rational Expectations and Efficiency in the London Metal Exchange," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 50(1), pages 41-52, February.
  14. Moore, Michael J & Cullen, Ursula, 1995. "Speculative Efficiency on the London Metal Exchange," The Manchester School of Economic & Social Studies, Blackwell Publishing, vol. 63(3), pages 235-56, September.
  15. Hiemstra, Craig & Jones, Jonathan D, 1994. " Testing for Linear and Nonlinear Granger Causality in the Stock Price-Volume Relation," Journal of Finance, American Finance Association, vol. 49(5), pages 1639-64, December. [Downloadable!] (restricted)
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  1. Bekiros, S. & Diks, C.G.H., 2007. "The Relationship between Crude Oil Spot and Futures Prices: Cointegration, Linear and Nonlinear Causality," CeNDEF Working Papers 07-11, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance. [Downloadable!]
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