Hedging and speculative pressures and the transition of the spot-futures relationship in energy and metal markets |
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| Institution: | 1. School of Economics, Finance and Accounting, Coventry University, UK;2. School of Management, University of Leicester, UK;1. Frankfurt School of Finance and Management, Sonnemannstraße, Frankfurt, Germany;2. ZEW Mannheim, P.O. Box 103443, 68034 Mannheim, Germany;3. BP p.l.c., 1 St. James''s Square, SW1Y 4PD London, UK;4. Aarhus University, Fuglesangs Allé 4, 8000 Aarhus, Denmark;5. True North Institute, 145-157 St. John Street, EC1V 4PY London, UK;1. Department of Agricultural Economics, Texas A&M University, USA;2. Department of Finance, Insurance, and Real Estate, Faculty of Business Administration, Université Laval, Canada;3. CRREP, Canada;4. CRIB, Canada |
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| 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. |
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