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Hedging vs. speculative pressures on commodity futures returns

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  • Cifarelli, Giulio
  • Paladino, Giovanna

Abstract

This study introduces a non linear model for commodity futures prices which accounts for pressures due to hedging and speculative activities. The linkage with the corresponding spot market is considered assuming that a long term equilibrium relationship holds between futures and spot pricing. Over the 1990-2010 time period, a dynamic interaction between spot and futures returns in five commodity markets (copper, cotton, oil, silver, and soybeans) is empirically validated. An error correction relationship for the cash returns and a non linear parameterization of the corresponding futures returns are combined with a bivariate CCC-GARCH representation of the conditional variances. Hedgers and speculators are contemporaneously at work in the futures markets, the role of the latter being far from negligible. In order to capture the consequences of the growing impact of financial flows on commodity market pricing, a two-state regime switching model for futures returns is developed. The empirical findings indicate that hedging and speculative behavior change across the two regimes, which we associate with low and high return volatility, according to a distinctive pattern, which is not homogeneous across commodities.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 28229.

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Date of creation: 10 Jan 2011
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Handle: RePEc:pra:mprapa:28229

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Keywords: Commodity spot and futures markets; dynamic hedging; speculation; non linear GARCH; Markov regime switching;

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  1. Stephen G. Cecchetti & Robert E. Cumby & Stephen Figlewski, 1986. "Estimation of the optimal futures hedge," Research Working Paper, Federal Reserve Bank of Kansas City 86-10, Federal Reserve Bank of Kansas City.
  2. Benninga, Simon & Eldor, Rafael & Zilcha, Itzhak, 1983. "Optimal hedging in the futures market under price uncertainty," Economics Letters, Elsevier, Elsevier, vol. 13(2-3), pages 141-145.
  3. Baillie, Richard T & Myers, Robert J, 1991. "Bivariate GARCH Estimation of the Optimal Commodity Futures Hedge," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 6(2), pages 109-24, April-Jun.
  4. Kroner, Kenneth F. & Sultan, Jahangir, 1993. "Time-Varying Distributions and Dynamic Hedging with Foreign Currency Futures," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 28(04), pages 535-551, December.
  5. Alizadeh, Amir H. & Nomikos, Nikos K. & Pouliasis, Panos K., 2008. "A Markov regime switching approach for hedging energy commodities," Journal of Banking & Finance, Elsevier, Elsevier, vol. 32(9), pages 1970-1983, September.
  6. Garbade, Kenneth D & Silber, William L, 1983. "Price Movements and Price Discovery in Futures and Cash Markets," The Review of Economics and Statistics, MIT Press, vol. 65(2), pages 289-97, May.
  7. Paul Cashin & C John McDermott & Alasdair Scott, 1999. "The myth of co-moving commodity prices," Reserve Bank of New Zealand Discussion Paper Series G99/9, Reserve Bank of New Zealand.
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  9. Stephen Fagan & Ramazan Gencay, 2008. "Liquidity-Induced Dynamics in Futures Markets," EERI Research Paper Series EERI_RP_2008_01, Economics and Econometrics Research Institute (EERI), Brussels.
  10. Figuerola-Ferretti, Isabel & Gonzalo, Jesús, 2010. "Modelling and measuring price discovery in commodity markets," Journal of Econometrics, Elsevier, Elsevier, vol. 158(1), pages 95-107, September.
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  12. Lence, Sergio H., 1995. "The Economic Value of Minimum-Variance Hedges," Staff General Research Papers, Iowa State University, Department of Economics 5053, Iowa State University, Department of Economics.
  13. Figlewski, Stephen, 1984. " Hedging Performance and Basis Risk in Stock Index Futures," Journal of Finance, American Finance Association, American Finance Association, vol. 39(3), pages 657-69, July.
  14. René M. Stulz, 1996. "Rethinking Risk Management," Journal of Applied Corporate Finance, Morgan Stanley, Morgan Stanley, vol. 9(3), pages 8-25.
  15. Donald Lien & Yiu Kuen Tse, 2000. "Hedging downside risk with futures contracts," Applied Financial Economics, Taylor & Francis Journals, Taylor & Francis Journals, vol. 10(2), pages 163-170.
  16. Ederington, Louis H, 1979. "The Hedging Performance of the New Futures Markets," Journal of Finance, American Finance Association, American Finance Association, vol. 34(1), pages 157-70, March.
  17. Bessembinder, Hendrik, 1992. "Systematic Risk, Hedging Pressure, and Risk Premiums in Futures Markets," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 5(4), pages 637-67.
  18. Lescaroux, François, 2009. "On the excess co-movement of commodity prices--A note about the role of fundamental factors in short-run dynamics," Energy Policy, Elsevier, Elsevier, vol. 37(10), pages 3906-3913, October.
  19. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, Econometric Society, vol. 57(2), pages 357-84, March.
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