Economic linkages across commodity futures: Hedging and trading implications (2009)
This 2009 paper looks at the price and quantity links between three commodities traded on TOCOM in Tokyo, palladium, gasoline and natural rubber. In the short run Palladium volume and volatility is affected by natural rubber but it is not found to affect the 2 other variables. In the longer run palladium volatility drives natural rubber volume. Long run Palladium volume is affected by gasoline volatility. It is reasoned that these three commodities are all used in industry together and that the underlying links begin there.
Methodology: VAR, Principle component analysis
Data: Daily data from the TOCOM website: Opening, high, low and closing prices; volume and open interest. February 2000 to the end of March 2008.
Citation: Chng, Michael T. “Economic linkages across commodity futures: Hedging and trading implications.” Journal of Banking & Finance 33.5 (2009): 958-970.
Abstract: We investigate cross-market trading dynamics in futures contracts written on seemingly unrelated commodities that are consumed by a common industry. On the Tokyo Commodity Exchange, we find such evidence in natural rubber (NR), palladium (PA) and gasoline (GA) futures markets. The automobile industry is responsible for more than 50% of global demand for each of these commodities. VAR estimation reveals short-run cross-market interaction between NR and GA, and from NR to PA. Cross-market influence exerted by PA is felt in longer dynamics, with PA volatility (volume) affecting NR (GA) volume (volatility). Our findings are robust to lag-specification, volatility measure, and consistent with full BEKK-GARCH estimation results. Further analysis, which benchmarks against silver futures market, TOCOM index and TOPIX transportation index, confirms that our results are driven by a common industry exposure, and not a commodity market factor. A simple trading rule that incorporates short-run GA and long-run PA dynamics to predict NR return yields positive economic profit. Our study offers new insights into how commodity and equity markets relate at an industry level, and implications for multi-commodity hedging.