Commodity futures indexes and related exchange traded notes: Linear and nonlinear adjustment

Abstract

Recent financialization of the commodity futures markets has led to the introduction of exchange traded products (ETP) that are directly linked to some underlying commodity futures contracts. One such ETP is known as exchange traded notes (ETN). This article examines the long-run relationship between a set of 19 ETN markets and their underlying commodity futures indexes. It also investigates whether the long-run adjustment process is linear or nonlinear. The article employs daily data spanning from January 2009 to December 2011, and utilizes the Engle-Granger cointegration framework allowing for linear and nonlinear adjustment processes through the error correction term. The results indicate the existence of long-run cointegration between ETN prices and the values of their underlying commodity indexes. The long-run adjustment processes between these markets, however, exhibit nonlinearity, which can be attributed to a number of factors including the time lag involved in the process of creation and redemption of share units of an ETN.