An examination of commodity derivative markets: efficiency, volatility and diversification benefits

This thesis comprises three papers which all examine commodity derivative markets and have a particular focus on commodity futures markets. The first paper examines market efficiency in metal, agricultural, financial and energy futures markets across different maturities. In the long-run, we found all markets to be efficient. And in the short-run, inefficiencies are found in the metal and energy future markets but not in the agricultural and financial markets. Moreover, results from a quantitative measure of short-run inefficiency indicate that all markets studied are at least 90% efficient along the futures curve for a 30-day forecast horizon. When the forecast horizon increases to 60-days, the efficiency measure drops to 50% in all the metal and energy futures markets, but not in the agricultural and financial markets. These findings indicate that the structure of markets and the forecast horizon are important factors to consider when assessing market efficiency. The second paper analyses the diversification benefits brought into traditional stock portfolios by adding commodities such as WTI Crude Oil, Copper or Soya Bean futures. Adopting a commodity futures curves perspective, we found that commodities are still useful in portfolio diversification even after the recent increase in the correlation between returns of commodities and equities. Moreover, we found that investors would be better off using a constant-distant maturity futures contract as it has higher return accompanied with lower volatility in comparison to a short-maturity futures contract. The constant-distant maturity also brings more benefit than a traditional buy and hold long-maturity futures contract does. Furthermore, we found the constant-distant maturity Copper futures to be the best among all the commodities that we studied regarding the diversification benefit during the financial turmoil period. The third paper examines the determinants of volatility along WTI Crude Oil futures curves. We analyse the effect of inventory, trading volume, open interest and speculative activities on the volatility of futures with different maturities. We find that trading volume has a positive relationship with volatility and open interest has a negative relationship with volatility. The inventory is found to have a negative relationship with volatility of up to 6-month maturity; while a positive relationship emerges for futures contracts with 12 and 18-month maturity. Speculative activities are found to be partially responsible for the high volatility in the post-crisis period.