The financialization of commodities documented in [Tang and Xiong (2012) Financial Analyst Journal, 68:54-74]has led commodity prices to exhibit not only time-varying volatility, but also price and volatility jumps. Using the class of stochastic volatility (SV) models, we incorporate such extreme price movements to generate out-of-sample hedge ratios. In-sample estimation on China's copper (CU) and aluminum (AL) spot and futures markets confirms the presence of price jumps and price-volatility jump correlations. Out-of-sample hedge ratios from the [Bates (1996) Review of Financial Studies, 9:69-107] SV with price jumps model deliver the greatest risk reduction on the unhedged positions at 59.55% for CU and 49.85% for AL. But it is the [Duffie, Pan, and Singleton (2000) Econometrica, 68:1343-1376] SV model with correlated price and volatility jumps that produces hedge ratios which yield the largest Sharpe Ratios of 0.644 for CU and 0.886 for AL.
We examine the market quality of China's steel rebar futures, along with three other important industrial metal futures. Steel rebar futures are the most active metal futures contracts in China. Our analyses show that while steel rebar and copper futures are comparable in terms of informational efficiency, they are more informationally efficient than iron ore and aluminum futures, with low bid–ask spread, volatility persistence, pricing error variance, and probability of informed trading. We find a bidirectional connection between iron ore and steel rebar futures. Furthermore, we show that these metal futures are weakly related to the Chinese stock market.
To study the market quality of commodity futures markets, we construct a commodity futures market quality index from the perspective of liquidity, efficiency, and volatility. Based on the market quality index, the Chinese commodity futures market operates steadily. The metal futures market is more efficient and stable than the market for agricultural futures. The Chinese commodity futures market is less liquid and more volatile than the U.S. market. We examine the determinants of market quality and find that macroeconomic variables and futures market contracts are significantly related to the market quality of Chinese commodity futures.
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