On the short-and long-run efficiency of energy and precious metal markets (2013)
This paper looks at the ability of the futures markets for all four precious metals to act as unbiased predictors of the future spot price. This idea is then developed to assess whether the precious metals market can be considered to be efficient. This is addressed as both a test of long run and short run efficiency, as markets have been shown on a number of occasions to pass through short periods where they act irrationally, but might be efficient over the longer term.
A long run equilibrium relationship between spot and futures prices is found for all 4 precious metals using a variety of cointegration tests, giving some evidence for long run efficiency. Using this the authors test for weak form market efficiency (that prices include all available information) assuming that investors are risk neutral and find that all four metals fail the test. This may be due to either investors being risk averse (which is likely) and/or the market is inefficient. However the result do not seen to be corrected for autocorrelation and therefore may be suspect.
The short run dynamics of the 4 spot prices also calls into question the efficiency of the markets. Prior changes in spot prices all have a significant effect on current changes, while lagged changes in platinum futures prices also effect it’s spot price. Allowing for a time varying risk premium does not change much, bar silver spot prices are also now effected by lagged silver futures prices. This mean reversion to the long run equilibrium is also shown to be best modelled as a non-linear process.
Method: Cointegration and Error correction models including the exponential smooth transition error correction model.
Data: Daily closing prices for futures (3 month COMEX) and spot (bloomberg): Gold, Silver, Platinum and Palladium. 01/04/1999 to 03/31/2011
Full Citation: Arouri, M., Hammoudeh, S, Lahiani, A. and Khuong Nguyen, D. (2013) “On the short-and long-run efficiency of energy and precious metal markets.” TEL Archives.
Abstract: This article contributes to the related literature by empirically investigating the efficiency of nine energy and precious metal markets over the last decades, employing several pronounced models. We test for both the short and the long-run efficiency using, in addition to linear cointegration models, nonlinear cointegration and error correction models (ECM) which allow the efficiency intensity to change per regime. Our findings can be summarized as follows: i) futures prices are found to be cointegrated with spot prices, but they do not constitute unbiased predictors of future spot prices; ii) the hypothesis of risk neutrality is rejected and there is some evidence of time-varying risk premia; iii) the short-run efficiency hypothesis is rejected, suggesting that using past futures price returns improves the modelling and forecasting of future spot prices; and iv) the nonlinear modelling suggests the presence of two distinct regimes where in the first regime the efficiency hypothesis is supported, whereas in the second it is rejected. The empirical findings have important implications for producers, hedgers, speculators and policymakers.