Cointegration and Detectable Linear and Nonlinear Causality: Analysis Using the London Metal Exchange Lead Contract

30 Pages Posted: 16 May 2003

See all articles by An-Sing Chen

An-Sing Chen

National Chung Cheng University - Department of Finance

Abstract

This paper applies linear and nonlinear Granger causality tests to examine the dynamic relation between London Metal Exchange (LME) cash prices and three possible predictors. The analysis uses matched quarterly inventory, UK Treasury bill interest rates, futures prices and cash prices for the commodity lead traded on the LME. We also examine the effects of cointegration on both linear and nonlinear Granger causality tests. When cointegration is not modeled, we find evidence of both linear and nonlinear causality between cash prices and analyzed predictor variables. However, after controlling for cointegration, we no longer find evidence of significant nonlinear causality. Our results contribute to the empirical literature on commodity price forecasting by highlighting the relationship between cointegration and detectable linear and nonlinear causality. We also illustrate the importance of interest rate and inventory as well as futures price in forecasting cash prices. Our failure to detect significant nonlinearity after controlling for cointegration may also go some way to explaining the reason for the disappointing forecasting performances of many nonlinear models in the general finance literature. It may be that the variables are correct, but the functional form is overly complex and a standard VAR or VECM may often apply.

JEL Classification: C50

Suggested Citation

Chen, An-Sing, Cointegration and Detectable Linear and Nonlinear Causality: Analysis Using the London Metal Exchange Lead Contract. EFMA 2003 Helsinki Meetings. Available at SSRN: https://ssrn.com/abstract=392025 or http://dx.doi.org/10.2139/ssrn.392025

An-Sing Chen (Contact Author)

National Chung Cheng University - Department of Finance ( email )

Chia-Yi, Taiwan 621
China
+011 886 5 272 0411 (Phone)
+011 886 5 272 0818 (Fax)

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