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Comparing different economic linkages among commodity futures

journal contribution
posted on 2010-11-01, 00:00 authored by M Chng
Gasoline (GA) and kerosene (KO) are extracted from crude oil (CO), such that the three fuel commodities share a chemical link. On the other hand, GA also shares an industrial link with natural rubber (NR) and palladium (PA) as complementary commodities that are heavily consumed by the automobile industry. We contrast the information content embedded in the two economic linkages. Focusing on TOCOM futures contracts written on the five commodities and centering on GA, we confirm that incremental information provided by either CO, KO or NR, PA over a buy-and-hold strategy and a naive forecast, are both statistically and economically significant. While the chemical link forecast is more profitable, a double-link forecast generated from a VECM with two cointegrating vectors (KO-GA and GANR prices) outperforms both single-link forecasts based on risk-adjusted profit net of transaction costs. Further comparisons against the profitability of commodity-based momentum strategies documented in Erb and Harvey (2006) and Miffre and Rallis (2007) show that the double-link forecast holds its own against the most profitable of the 75 momentum strategies considered. This strongly suggests that not only are there incremental profits to be gained from harnessing and combining economic links among commodity futures, the resultant incremental profits are economically significant against other proven commodity-based trading strategies in the existing literature.

History

Journal

Journal of business finance & accounting

Volume

37

Issue

9-10

Season

November - December

Pagination

1348 - 1389

Publisher

Blackwell Publishing

Location

Oxford, England

ISSN

0306-686X

eISSN

1468-5957

Language

eng

Publication classification

C1 Refereed article in a scholarly journal

Copyright notice

2010, Blackwell Publishing Ltd

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