Demystifying Commodity Futures in China

Abstract

This paper investigates the commodity futures risk premia in China. In the presence of excessive speculation and barriers-to-entry, the term structure and momentum premia remain persistent, whereas hedging pressure, skewness, volatility and liquidity premia are distorted by the time-varying margins and strict position limits. Furthermore, we show that open interest, currency and inflation premia are sensitive to the institutional settings. The observed premia cannot be attributed to aggregate market risks, none-tradable macroeconomic risks, sentiments, transactions costs or data-snooping. However, liquidity, anchoring, and regulation-induced “limits-to-arbitrage” provide a partial explanation. Finally, systematic strategies that exploit roll-yields, past returns and hedging pressure exhibit promising potential for portfolio diversification. Overall, the paper highlights the distinction between the US and Chinese commodity markets, sheds light on the effectiveness of risk-transfer in China, and poses challenges to existing theories on commodity risk premia.

Keywords: China, commodity futures, speculation, position limits, margins, price discovery, momentum, term structure, hedging pressure, liquidity, diversification

JEL Classification: G13, G14, G15, G41, N25, Q02