Do the Basis and Other Predictors of Futures Return Also Predict Spot Return with the Same Signs and Magnitudes? Evidence from the LME

89 Pages Posted: 28 Jan 2019 Last revised: 5 Mar 2021

See all articles by Jian Jia

Jian Jia

Illinois Institute of Technology - Stuart School of Business

Sang Baum Kang

Illinois Institute of Technology - Stuart School of Business

Date Written: July 6, 2020

Abstract

The LME is a major international commodity exchange for industrial metals. Both futures contracts and spot metals are traded there, and the textbook principle of the futures-spot convergence precisely holds there. In this paper, we formulate two claims about spot and futures return prediction. First, the predictors of futures price return should also predict spot price return with the same signs and magnitudes under certain conditions. Second, the futures-spot basis is an exception. These claims lead to testable hypotheses, and provide theory-based restrictions for the coefficients of spot and futures return regressions. We investigate six industrial metals and find empirical support for our hypotheses. The in-sample and out-of-sample evidence shows that financial variables, proxies for global economic activities, and the basis predict futures and spot price returns consistently with our hypotheses. Furthermore, our out-of-sample trading exercises document economic significance of the restrictions.

Keywords: futures return predictability, spot return predictability, basis, commodity, industrial metal

JEL Classification: G12, G13, Q02

Suggested Citation

Jia, Jian and Kang, Sang Baum, Do the Basis and Other Predictors of Futures Return Also Predict Spot Return with the Same Signs and Magnitudes? Evidence from the LME (July 6, 2020). Available at SSRN: https://ssrn.com/abstract=3315915 or http://dx.doi.org/10.2139/ssrn.3315915

Jian Jia

Illinois Institute of Technology - Stuart School of Business ( email )

Stuart Graduate School of Business
565 W. Adams St. 4th floor
Chicago, IL 60661
United States

Sang Baum Kang (Contact Author)

Illinois Institute of Technology - Stuart School of Business ( email )

565 W Adams St
Room 454
Chicago, IL
United States
312-906-6577 (Phone)

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