Hedging and Speculative Pressures and the Transition of the Spot-Futures Relationship in Energy and Metal Markets

Abstract

This paper examines the impact of hedging and speculative pressures on the transition of the spot-futures relationships in the energy and metal markets. We build a Markov regime switching (MRS) model where hedging and speculative pressures affect the transition probabilities of spot-future relationship between high-return low-volatility (bull) and low-return high-volatility (bear) markets. It is discovered that hedging pressure, measured based on net open interests, increases the likelihood of the transition while speculative pressure is likely to sustain an ongoing spot-futures relationship in copper, silver, crude oil and natural gas markets. Conversely, in gold markets where the pressures are more long-term oriented, hedging activity decreases the transition probability while speculative activity increases it. The basis-based benchmark measures do not have any significance. We also examine whether the MRS models including hedging or speculative pressures in transition probabilities are able to improve hedging performance in in- and out-of-samples. The derived minimum variance hedge (MVH) ratios lead to stronger hedging performances against various static and dynamic benchmark strategies in copper, silver, gold and crude oil markets.

Keywords: Energy markets; Metal markets; Hedging pressure; Speculative pressure; Hedging performances

JEL Classification: G13