Finance Researchers Show Their Mettle in Futures Predictability Study
Researchers at Illinois Institute of Technology’s Stuart School of Business have done some heavy lifting in a study of the industrial metals market, with results that yield direct benefits for finance professionals and other businesspeople who focus on commodities futures.
In “Do the Basis and Other Predictors of Futures Return Also Predict Spot Return with the Same Signs and Magnitudes? Evidence from the LME,” published in the Journal of Commodity Markets, Associate Professor of Finance Sang Baum “Solomon” Kang and one of his former students, Amazon.com, Inc. economist Jian Jia (Ph.D. MSC ’20), investigate spot-futures convergence, a principle about how futures and spot prices should move together. They tested their hypotheses using a 20-year span of data from the London Metal Exchange (LME), a leading international platform for publicly trading industrial metals.
“We theoretically show that most predictors [used by analysts in spot and futures price prediction models] forecast spot and futures returns with the same sign and magnitude, but the futures-spot basis is an exception,” Kang says. “The coefficient of the basis in a predictive regression for futures return must be lower than that for spot return, and this is the simplest explanation for why the basis negatively predicts futures returns. We empirically show that these theoretical restrictions make speculative and hedging strategies in commodity markets more accurate.”
“Our findings are valuable for finance practitioners who need to predict both futures and spot prices, such as investors and hedgers,” says Kang, “as well as producers, storage operators, commodity processors, and others in industries that use the metals.”
This work also moves academic research in the field forward, according to Kang, by documenting a novel restriction on the co-movement of spot and futures prices and measuring futures returns consistently with economic theory.
Photo: Associate Professor of Finance Sang Baum “Solomon” Kang