Commodity Futures Returns: A Non Linear Markov Regime Switching Model of Hedging and Speculative Pressures

University of Florence Department of Economics Working Paper No. 13/2010

34 Pages Posted: 20 Nov 2010

See all articles by Giulio Cifarelli

Giulio Cifarelli

DISEI University of Florence

Giovanna Paladino

IntesaSanpaolo; LUISS Economics Department

Date Written: November 19, 2010

Abstract

This study introduces a non linear model of commodity futures prices which accounts for the pressures due to hedging and speculative activities. The interaction 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. Finally, 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 significantly across the two regimes, which we associate with low and high return volatility. High volatility regimes are, as expected, characterized by a stronger impact of speculation on futures return dynamics.

Keywords: Commodity Spot and Futures Markets, Hedging, Speculation

JEL Classification: G13, G15, Q47

Suggested Citation

Cifarelli, Giulio and Paladino, Giovanna, Commodity Futures Returns: A Non Linear Markov Regime Switching Model of Hedging and Speculative Pressures (November 19, 2010). University of Florence Department of Economics Working Paper No. 13/2010. Available at SSRN: https://ssrn.com/abstract=1711807 or http://dx.doi.org/10.2139/ssrn.1711807

Giulio Cifarelli (Contact Author)

DISEI University of Florence ( email )

via delle Pandette 9
Florence 50127
Italy

Giovanna Paladino

IntesaSanpaolo ( email )

Piazza San Carlo
Torino, 10121
Italy

LUISS Economics Department ( email )

Viale di Villa Massimo, 57
Rome, 00161
Italy

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