Do the basis and other predictors of futures return also predict spot return with the same signs and magnitudes? Evidence from the LME

Jian Jia and Sang Baum Kang

Journal of Commodity Markets, 2022, vol. 25, issue C

Abstract: The LME is a major international commodity exchange for industrial metals. Both futures contracts and spot metals are traded there, and the textbook principle of the futures-spot convergence precisely holds there. In this paper, we formulate two claims about spot and futures return prediction. First, the predictors of futures price return should also predict spot price return with the same signs and magnitudes under certain conditions. Second, the futures-spot basis is an exception. These claims lead to testable hypotheses, and provide theory-based restrictions for the coefficients of spot and futures return regressions. We investigate six industrial metals and find empirical support for our hypotheses. The in-sample and out-of-sample evidence shows that financial variables, proxies for global economic activities, and the basis predict futures and spot price returns consistently with our hypotheses. Furthermore, our out-of-sample trading exercises document economic significance of the restrictions.

Keywords: Futures return predictability; Spot return predictability; Basis; Commodity; Industrial metal (search for similar items in EconPapers)
JEL-codes: G12 G13 Q02 (search for similar items in EconPapers)
Date: 2022
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jocoma:v:25:y:2022:i:c:s2405851321000210

DOI: 10.1016/j.jcomm.2021.100187

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