Relative Basis and Expected Returns in Commodity Futures Markets

67 Pages Posted: 21 Jun 2019 Last revised: 28 Oct 2021

See all articles by Ming Gu

Ming Gu

Xiamen University - School of Economics

Wenjin Kang

School of Finance, Shanghai University of Finance and Economics

Dong Lou

London School of Economics & Political Science (LSE); Centre for Economic Policy Research (CEPR)

Ke Tang

Institute of Economics, School of Social Sciences, Tsinghua University

Date Written: June 15, 2019

Abstract

We propose a novel measure, namely relative basis, as a more precise proxy for the
convenience yield implied by the Theory of Storage. The relative basis, defined as the
difference between the traditional near-term basis and a similarly defined longer-term
basis, purges out the interference from the storage cost and financing cost. The relative
basis dominates the traditional basis in terms of predicting subsequent commodity
futures returns. In contrast, it cannot predict the returns of financial futures that have
no inventory concern. Additional analysis further confirms that the return predictability
of relative basis in commodity markets comes from the Theory of Storage instead of the
Theory of Normal Backwardation.

Keywords: relative basis, commodity futures, expected return, convenience yield, theory of storage

JEL Classification: G12, G13

Suggested Citation

Gu, Ming and Kang, Wenjin and Lou, Dong and Tang, Ke, Relative Basis and Expected Returns in Commodity Futures Markets (June 15, 2019). Available at SSRN: https://ssrn.com/abstract=3404561 or http://dx.doi.org/10.2139/ssrn.3404561

Ming Gu

Xiamen University - School of Economics ( email )

Xiamen, Fujian
China

Wenjin Kang

School of Finance, Shanghai University of Finance and Economics ( email )

777 Guoding Road
Shanghai, Shanghai 200433
China

Dong Lou

London School of Economics & Political Science (LSE) ( email )

Department of Finance
Houghton Street
London, WC2A 2AE
United Kingdom
+44 (0)207 1075360 (Phone)

HOME PAGE: http://personal.lse.ac.uk/loud/

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Ke Tang (Contact Author)

Institute of Economics, School of Social Sciences, Tsinghua University ( email )

No.1 Tsinghua Garden
Beijing, 100084
China

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