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Hedging and speculative pressures and the transition of the spot-futures relationship in energy and metal markets

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  • Park, Jin Suk
  • Shi, Yukun

Abstract

This paper examines the impact of hedging and speculative pressures on the transition of the spot-futures relationship in metal and energy markets. We build a Markov regime switching (MRS) model where hedging and speculative pressures affect the transition probabilities between a stronger and weaker spot-futures relationship. It is found that hedging pressure increases the likelihood of transition, i.e. destabilises the existing spot-futures relationship, while speculative pressure reduces it, i.e. stabilises the relationship, in the copper, crude oil and natural gas markets, but this effect is relatively weak in the silver and heating oil markets. We also examine whether these findings generate practical benefits by testing the hedging effectiveness of the minimum variance hedge ratios (MVH) derived from the MRS models with hedging and speculative pressures. A relatively strong reduction of the portfolio variance, hedger's utility and value at risk (VaR) is observed in the energy markets.

Suggested Citation

  • Park, Jin Suk & Shi, Yukun, 2017. "Hedging and speculative pressures and the transition of the spot-futures relationship in energy and metal markets," International Review of Financial Analysis, Elsevier, vol. 54(C), pages 176-191.
  • Handle: RePEc:eee:finana:v:54:y:2017:i:c:p:176-191
    DOI: 10.1016/j.irfa.2016.12.001
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    More about this item

    Keywords

    Energy markets; Metal markets; Hedging pressure; Speculative pressure; Spot and futures relationship; Hedging performance;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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